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.