There were no surprises that came from today’s FOMC meeting. The Fed decided to hold off again on a rate hike. It also announced that they “will initiate the balance sheet normalization program” in October. Both the FOMC statement and the Fed’s projections suggest a December rate hike is still likely.
Increased Odds for a December Fed Rate Hike
One reason the Fed may decide against a December rate hike is if inflation numbers are too low. Today’s statement doesn’t indicate that the Fed has any additional concerns about inflation. It did mention that the “hurricanes will likely boost inflation temporarily.” However, the Fed continues to expect inflation “to stabilize around the Committee's 2 percent objective over the medium term.”
The Fed’s projections did lower the 2017 inflation expectations slightly, but there were no changes in the 2018 expectations. So that shouldn’t change the December rate hike decision. New GDP projections were increased for 2017 and future years. New unemployment projections were slightly reduced in 2018 and 2019. These changes should help the case of a December rate hike.
The most interesting projection for savers is the “dot plot” of the federal funds rate. Out of the 16 FOMC participants, 12 anticipate a rate hike. Only four anticipate no change. That suggests that most on the Fed are ready for a December rate hike if the economy can avoid any major issues.
The odds of a December rate hike did go up today based on the Fed Fund futures as shown by the CME Group FedWatch Tool. The odds increased from 63.3% to 72.8%.
One disappointing issue is that the Fed continues to lower the projected longer run federal funds rate. The dot plot indicates a median longer run federal funds rate of 2.75%. That’s down from 3.00% that was projected in June. Fed Chair Janet Yellen mentioned this in her press conference. She noted that there’s general recognition over the last few years that the neutral interest rate has come down. This means it’s very unlikely that we’ll see interest rates close to where they were back in 2006. The federal funds rate may not exceed 3% for the next five years.
Balance Sheet Reduction and CD Rates
The Fed’s announcement that it will start the balance sheet reduction program in October was expected. This should put upward pressure on longer-term rates. The balance sheet reduction reverses the quantitative easing (QE) that took place during the zero-interest rate years. An important reason that the Fed implemented QE was to suppress longer-term interest rates. Thus, reversing QE should have the opposite effect and push up longer-term interest rates.
As I mentioned in the weekly summary, we probably won’t see any large impact on longer-term rates, including long-term CD rates. The balance sheet reduction has been expected for much of this year, and long-dated Treasury yields have actually fallen this year.
It’s possible that the balance sheet reduction will help CD rates to some extent. What happened in 2013 shows how QE changes can affect longer-term rates. That was the year that the Fed began to taper QE. When tapering was first mentioned, the markets panicked in a reaction that was known as the Taper Tantrum. The result was that long-dated Treasury yields increased significantly. For example, the day before Fed Chair Ben Bernanke mentioned tapering in May, the 10-year yield was 1.94%. Tapering was officially announced at the December 18th Fed meeting. By December 26, the 10-year yield had reached 3.00%.
The rise of Treasury yields during the Taper Tantrum of 2013 did seem to have an impact on CD rates. December 2013 was when PenFed came out with 5- and 7-year CDs with a 3.04% APY. It should be noted that PenFed’s rates were the exception. Nevertheless, 5-year CD rates overall did rise in 2013. Looking at just internet banks, the highest 5-year CD rate in May 3, 2013 was 1.85% APY. On December 20, 2013, the highest 5-year CD rate for internet banks was 2.16% APY.
Deposit Account Strategies
I think we are all waiting for the return of the 3% CDs. We’re slowly moving that way. Unfortunately, this movement has been very slow. For example, the highest 5-year CD rate that’s nationally available from a credit union is 2.60% APY. The highest from an internet bank is 2.40% APY. The top 5-year brokered CD rate last week was 2.35%. At the start of 2017, the highest 5-year credit union rate was 2.60% APY, the highest 5-year internet bank rate was 2.28% APY and the highest 5-year brokered CD rate was 2.30%. As you can see, the rise has been very small and gradual.
Based on this history, I’m hesitant to say that 3% 5-year CDs are right around the corner. The balance sheet reduction program may help a little. Also, if the economy performs as the Fed expects and we see a Fed rate hike in December and three rate hikes in 2018, it seems very likely that long-term rates will have to eventually move up. Consequently, it still seems reasonable to expect that we’ll see several 3% 5-year CDs in 2018. Thus, you may want a strategy of parking your money in top internet savings accounts like Dollar Savings Direct or in a No Penalty CD like Ally’s 11-month No Penalty CD. When we finally see those 3% 5-year CDs, you can then jump on them.
The above strategy has risks. We have been disappointed many times in the past with the hopes of rate hikes. We may not see 3% 5-year CDs in the next year or two. If you want to keep things simple, stick with a standard CD ladder with 5-year CDs maturing at regular intervals. If you’re worried about missing future hot CD deals, choose 5-year CDs with early withdrawal penalties that are no higher than six months of interest. This will allow you to break the CDs without too much cost and redeploy the funds into those higher-rate CDs. You can use our 5-year CD rate table and our CD Early Withdrawal Penalty Calculator to review these 5-year CDs.
For more strategy discussion, please see my article from January, Deposit Account Strategies for 2017.
Future FOMC Meetings
The next three FOMC meetings are scheduled for October/November 31-1, December 12-13 and January 30-31, 2018. The December meeting will include the summary of economic projections and a press conference by Fed Chair Yellen.