Fed Holds Rates Steady - Odds Are Up for March Rate Hike


Fed Holds Rates Steady - Odds Are Up for March Rate Hike

As expected, no policy changes were announced today at the end of the two-day FOMC meeting. The Fed decided to hold off on a rate hike, but a rate hike in March still looks very likely. The language in the FOMC statement describing the economy is very similar to the language that was in the December statement. The only significant difference is that the Fed acknowledged recent increases in inflation. For example, in the December FOMC statement, the Fed had the following description of inflation and future inflation expectations:

Market-based measures of inflation compensation remain low


Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term.

In today’s FOMC statement, you can see how the above lines have changed:

Market-based measures of inflation compensation have increased in recent months but remain low


Inflation on a 12-month basis is expected to move up this year and to stabilize around the Committee's 2 percent objective over the medium term.

All of the voting FOMC members voted in favor of today’s policy action.

Rising Odds for a March Fed Rate Hike

The odds of a March Fed rate hike went up today. According to the Fed Fund futures as shown by the CME Group FedWatch Tool, the odds of a March rate hike is now 83.1%, which is up from 76.0% yesterday.

The odds are high, but they’re not high enough to call a March rate hike a sure thing. After the November Fed meeting, the odds of a December rate hike were 98%.

Future FOMC Meetings

The next three FOMC meetings are scheduled for March 20-21, May 1-2 and June 12-13. The March and June meetings will include the summary of economic projections and a press conference by the Fed Chair.

Fed Chair Janet Yellen’s Last Meeting

Janet Yellen's term as Fed Chair expires February 3. She will also leave the Federal Reserve Board of Governors. The new Fed chair will be Jerome Powell who has served on the Board of Governors since 2012.

Jerome Powell has consistently supported Janet Yellen’s policies so don’t expect any significant changes. Once Powell becomes the Fed Chair, the Board of Governors will still have four vacancies. President Trump has only nominated one candidate, Marvin Goodfriend, who has yet to be confirmed by the Senate. Three more will have to be nominated and confirmed.

In addition to the changes in the Board of Governors, four new Fed Bank presidents have rotated in as voting members on the FOMC for this year.

With all of these changes, should we expect the Fed to be any more hawkish in 2018? In general, hawkish members tend to focus more on inflation than unemployment and are more likely to push for higher interest rates. Dovish members, on the other hand, tend to focus more on unemployment and are more likely to favor lower interest rates.

Economist Tim Duy sums up his expectation for the new Fed in his recent Fed Watch blog post, “Is The Fed Ready To Turn Hawkish?”:

My expectation is that the hawkish tilt of both the voting rotation and the new leadership will dominate over the more dovish voices of last year.

So the Fed may be a little more hawkish in 2018 than they were in 2017. That should slightly increase the chance that we’ll see at least three Fed rate hikes this year.

Deposit Account Strategies

An important issue for savers is the decision of how much of their savings should go into long-term CDs vs short-term CDs and savings accounts. Long-term CDs are increasingly becoming less attractive as short-term rates rise more than long-term rates. For example, Live Oak Bank is now offering an 18-month CD with a 2.30% APY. The highest 5-year CD rate at an internet bank is currently 2.65% APY. That’s only 35 bps higher for a term that’s more than 3x longer.

Even an 18-month CD may be considered long-term when rates are rising. The highest savings account rate is currently 1.70% APY at ableBanking. That’s 60 bps under the top 18-month CD rate.

This compression of the yield curve in which short-term rates approach long-term rates will likely continue in 2018. In Tim Duy’s blog post, he explains why he thinks yield curve compression will continue:

I don’t think that the fundamental factors (saving glut, investment shortage, demographics) holding down long-term rates have eased yet.

A similar condition existed back in 2006 and 2007 when the Fed was hiking rates. I took a look back at my weekly summary in January 2007, and the top 5-year rate was 6.25% APY at PenFed. The top savings/money market account rate was 5.50% APY at Superior Savings (which was acquired by Capital One). At this time the federal funds rate was 5.25%.

Currently, the top savings/money market rate is 1.70% APY (at ableBanking) and the top 5-year CD rate is 3.00% APY (at Connexus Credit Union). The federal funds rate remains in a range of 1.25% to 1.50%.

Let’s assume we get three more Fed rate hikes in 2018 and three more in 2019. That would result in a federal funds rate in a range of 2.75% to 3.00% near the end of 2019. Let’s assume internet savings account rates exceed the federal funds rate in a pattern similar to both today and back in 2007. Also, let’s assume the top 5-year CD rates will be slightly higher than the top internet savings accounts. I think it could be anywhere from only 0 bps to what we see today (130 bps). For the sake of simplicity, let’s assume a range of 50 to 100 bps. So based on these assumptions, we can make guesses about the top internet savings account rates and top 5-year CD rates at the end of 2018 and 2019:

  • Possible Rates by the End of 2018:
    • federal funds rate: 2.00% to 2.25% (assumes 3 hikes in 2018)
    • top internet savings account rate: 2.25% to 2.50%
    • top 5-year CD rate: 3.00% to 3.50%
  • Possible Rates by the End of 2019:
    • federal funds rate: 2.75% to 3.00% (assumes 3 hikes in 2019)
    • top internet savings account rate: 3.00% to 3.25%
    • top 5-year CD rate: 3.75% to 4.25%

If we do see rates rise like this, how would today’s top CDs compare to keeping your money in a top savings account?

I’ll estimate the average earnings in a top savings account by taking the average of today’s top rate (1.70%) with the estimated top rate when the CD matures.

For 1-year CDs, today’s top rate is 2.11% APY at VirtualBank. The estimated top savings account rate one year from now is 2.50%. The average of 1.70% and 2.50% is 2.10% which is pretty much the same as today’s top 1-year CD rate.

For 18-month CDs, today’s top rate is 2.30% APY at Live Oak Bank. The estimated top savings account rate 18 months from now is about 2.88%. The average of 1.70% and 2.88% is 2.29% which is pretty much the same as today’s top 18-month CD rate.

As you can see, there may not be any advantage with choosing CDs instead of savings accounts today. Of course, this assumes rates keep rising in the pattern described above. Any shock to the economy that causes the Fed to pause rate hikes would give the advantage to today’s CDs.

Another thing to consider is the level of effort. I’m assuming you’ll keep your money in top savings accounts. Today’s top savings account rarely holds that position for long. You should anticipate that you’ll need to move your money roughly every six months to achieve the average rate estimated above.

If rates should happen to rise more than my estimates above, the advantage would go with savings accounts. Another nice thing about savings accounts is that they make it easy to take advantage of hot CD deals. You can quickly use money from your savings account to fund a hot CD. Of course, deciding if a CD is hot in a rising interest rate environment is difficult. Many readers did not look favorably at PenFed’s 6.25% long-term CDs back in 2007.

Another thing to consider is 5-year CDs with small early withdrawal penalties. With short-term rates rising faster than long-term rates, the effective yields of 5-year CDs closed early are lower than shorter-term CDs held to maturity. But they’re not so much lower that this strategy should be totally discounted. You can see how Ally Bank’s 5-year CD closed early compares to top shorter-term CDs held to maturity using our CD Early Withdrawal Calculator. As usual, beware of banks and credit unions with disclosures that give them the right to not allow an early closure, and beware of the possibility that a bank or a credit union will increase the early withdrawal penalty on existing CDs.

Att   |     |   Comment #1
I think rates will go up but slower than we think. I think The Fed is afraid of raising rates to quickly and will take a slow approach as to not have a negitive affect on the economy.
purecode   |     |   Comment #2
I disagree, I think once inflation picks up (I know I know, the sky is falling) which eventually will this year, the Fed will have no choice but to act. If they don't, they will have a much bigger issue than a market tantrum on their hands a few years from now.
Nothing   |     |   Comment #3
And, the Fed needs room to maneuver and low interest rates limits future options notwithstanding RE people inherently liking low rates!
Bogie   |     |   Comment #5
I never did think the Fed would raise rates any faster than they presently are.
I believe there is a lot of wishful thinking going on by many.
Mind Meld
Mind Meld   |     |   Comment #7
The US Federal Reserve has been taking a slow approach for many years. Perhaps people are finally conditioned to think of 3% as a high interest rate.

The rest of the world is taking things even more slowly. The only comparable rates globally from developed countries is Australia. US Treasuries are yielding more than UK junk bonds.
deplorable 1
deplorable 1   |     |   Comment #4
Judging from the reaction in the bond and REIT market you would think that the FED is going to hike rates much faster than forecast. At this point of the economic cycle rates should have been 5-6% by now already and should have started increasing during Obama's second term so as not to shock the market. Now if inflation picks up quickly which is a real possibility the FED will have to no choice but to hike rates fast. Not a good time to be locked into long term CD's under this scenario. For the folks lucky enough to have the GTE add-on CD's these will come in handy if the FED hikes remain slow. This is getting interesting.
Mind Meld
Mind Meld   |     |   Comment #6
It is fine to warn people about the risk of changes to things like early withdrawal penalties and the possibility of not being allowed to make withdrawals, but hanging out here, it is easy to understand people don't read the disclosure documents and membership disclosures and other fine print from credit unions. Perhaps it will take widespread action by credit unions to actually enforce those terms before people take them seriously, and it will tarnish the whole industry.

Also, actually terminating a CD early has risk. If rates are rising, and the "calculator" calculates a small positive gain from breaking early, taken to its logical extreme, as long as rates are rising, CDs will continually be broken, each time breaking even, with the sum result of breaking even, as in making close to zero dollars, instead of actually making money.
Bogie   |     |   Comment #8
Abiding by and enforcing and the terms and conditions set forth in the membership discloses and other fine print should not tarnish any CU or bank. But many people who think the "rules don't apply to them" would be shocked and most likely resent the action.
Mind Meld
Mind Meld   |     |   Comment #9
Bogie, case in point. Of course, banks don't have membership "discloses."

These are changes to existing CDs. A journalist inquired about a change made by the credit union. The credit union representative was unable to locate the document. Management eventually did.

Yes, everyone should understand the fine print, unless they are credit union employees or mortgage bank executives making fraudulent loans, which deserve taxpayer support.
Bogie   |     |   Comment #12
Of course, banks don't have "membership" disclosures. However the same terms and conditions are pointed out the banks' "Account Agreement forms".

Also, as many of us know, not all CU and banks' CSRs are not up to date and aware of their own institutions current policies. It is in the best interest of depositors to be very attentive to the current status of their accounts along with upcoming maturity dates. Personal responsibility comes to mind.........
Mind Meld
Mind Meld   |     |   Comment #13
I appreciate your sincerity, but can you point to a single bank that reserves the right to change the terms of a CD after issuance? Since you are bringing it up?

I guess it does make sense to hold customers to a higher standard than employees. Maybe not...
xxx   |     |   Comment #15
will a cu do?

Mind Meld
Mind Meld   |     |   Comment #16
What, my friend xxx?

No. Bogie commented that banks have similar policies to credit unions, and the question was to show a bank that actually claimed to be able to change a CD term retroactively. Showing that a credit union does not answer the question.
deplorable 1
deplorable 1   |     |   Comment #10
As a general rule I don't plan on ever breaking a CD. If I don't like the interest rate or term I'll just pass and wait for the next deal. I have had a few banks and credit unions fail to notify me of the CD's maturing and preemptively trying to roll them over into low yielding CD's before the grace period was even up. I always catch them and get the cash back without penalty after quoting them their own grace period rules. I feel these automatic CD renewal practices to be quite shady and designed to trick old folks into locking up their money at low rates. The default when a CD matures should be:
1. Notify the customer first before taking any action.
2. Transfer the money to a savings account.
3. Mail a check to the address on file.
Instead they default to renewing a CD a some super low crappy rate to shaft those not paying attention. This is my only real beef about CD's in general.
Kaight   |     |   Comment #11
Agreed, except there is more. It's not merely alone a question of failure to pay attention. There could also be a family or personal emergency (e.g., unanticipated hospitalization) or temporary incapacity which would interfere with ability to inhibit a renewal. You are totally correct that default to renewal is wrongheaded if irreversible.

I try to have my CDs re-coded, after opening, so that upon maturity all proceeds are transferred into savings. In some instances there is no problem. In other instances the financial institution raises a stink and tells me I need to make that change within a week or two of actual maturity.
Ecstatic   |     |   Comment #18
This "automatic CD renewal" option should NOT, by law, be the default option. My local bank told me they could not do it, which is total nonsense. A simple programming change is all that's required. This is simply an age-old technique to keep your money in their bank. They're counting on lazy people ignoring their account until it's too late. Why people have tolerated this is beyond me.
me1004   |     |   Comment #14
So, the Fed thinks a huge tax cut pumping money into a full-employment economy, and in the face of high consumer confidence and retail spending and wages on the rise, not to mention soaring prices for oil, will "stabilize" inflation -- so hold off on anything to counter it, don't even worry that rates still are not up to even a level to provide a reasonable launching point to fight inflation when it takes off?

We in a heap of trouble with these guys in charge. They must have been out sick the day they taught the lessons of inflation from the '70s and '80s in business school.
deplorable 1
deplorable 1   |     |   Comment #19
@me1004: I think they are well aware that they are behind the 8 ball which is why they are still hiking in spite of reducing their balance sheet. They just don't want to spook the markets ahead of time if they need to raise rates quickly. This may be the calm before inflation picks up.
For Ken
For Ken   |     |   Comment #17
Northpointe's Ultimate Checking 5% interest rate going to1% on March 1, 2018
deplorable 1
deplorable 1   |     |   Comment #20
Not a very nice way to reward loyal customers for jumping through debit card hoops. I thought about opening this for a while since it was local for the 5% but I figured it wouldn't last. Funny how banks will do this even as interest rates are rising.
deplorable 1
deplorable 1   |     |   Comment #21
The latest news seems to indicate that inflation expectations are rising at a faster pace than predicted earlier by the FED. This is effecting the bond and REIT market in a very substantial way. I would not be locking in any long term CD's at the moment because the interest rate landscape looks like it may change to the upside rather quickly. Many banks may now start offering 3% long term CD's because they want you to lock up your money long term in a rising interest rate environment. Don't take the bait as savings and MMA rates may actually end up beating them while keeping your cash liquid.
Bozo   |     |   Comment #22
Deplorable 1 (re comment #21), good observation. I'm somewhat partial to Vanguard's Prime Money Market Fund (VMMXX) and Alliant's high-yield savings.
deplorable 1
deplorable 1   |     |   Comment #23
@Bozo: Good job taking some profits off the table before this latest stock drop! I'm getting hammered but all I have to do is put my monthly dividends in the bank to lock in some profit. I'm going to open that GE smart note account for the 1.75%. I bet that rate will go past 3% in the near future with the rate hikes.
deplorable 1
deplorable 1   |     |   Comment #26
Whoops I meant GM right notes @ 1.75%.
Brokered   |     |   Comment #24
10-yr brokered at Schwab = 2.95%
Why aren't brokered rates included here?

I know people chase rates all day, opening and closing accounts and transferring funds from one location to another. My approach is to stay 95% invested most of the time with 95% safety. That means a lot of CD's. We generally buy 10-yr to get the highest current rate and let the chips fall as they may down the road. Our brokered CD's (the majority of CD's) do not not compound, thus generating free cash to invest or spend as we please. Note: Except for a $35K IRA our CD's are in after tax accounts.
QQQ   |     |   Comment #25
Vanguard has them too.
You're finding them in the "correct" places.
Continuing your search should help for the info you seek.
DCGuy   |     |   Comment #27
This is off topic since this isn't an investing forum.
The markets roared up again today, so the several thousand point drop a few weeks ago have mostly been recovered. I checked a stock price history (CAR) that I owned prior to the subprime implosion. The price dropped to a low of 38 cents in March 2009. Just last year, the price rose up to $68. It's dropped down since then. So had I bought out millions of shares in the basement, I could have sold at 68 times my initial purchase last year. 2 million shares would have sold for over $50 million. I could have retired immediately. But you have to act at the right time.
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