At the conclusion of the FOMC meeting, the Fed announced its fourth straight 75-bp rate hike. The target federal funds rate is now 3.75%-4.00%. This is now far above the peak of the last rate hiking cycle (2015-2018). We haven’t seen federal funds rates this high since early 2008.
Below are excerpts from today’s FOMC Statement that covers the rate decision:
the Committee decided to raise the target range for the federal funds rate to 3-3/4 to 4 percent
In the rate decision paragraph, there are hints that the Fed is preparing to slow the pace of the rate hikes. The excerpt below is what was added from the previous meeting statement:
The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.
All voting members voted in favor of today’s policy action.
There is no update to the Fed’s Summary of Economic Projections (SEP) at this meeting. The next Fed meeting on December 13-14 will provide SEP updates, including the federal funds rate dot plot.
More To Come
I plan to update this post later today with additional commentary on the Fed meeting and the Fed Chair press conference. In addition, I’ll discuss my take on deposit account strategy in this rising rate environment. I just wanted to publish this initial post so that comments can begin.
Update: The following content was added at 9:34pm EDT on Wednesday, November 2, 2022.
Post-Meeting Press Conference
That new addition to the FOMC statement opened the door to a smaller 50-bp rate hike in December. At the press conference, Fed Chair Powell opened the door to a higher terminal policy rate than what the Fed had suggested in September via the SEP. The dot plot of that SEP pointed to a peak rate of 4.50%-4.75% by the end of 2023. In Fed Chair Powell’s opening remarks, he warned that rates may have to go higher:
There is significant uncertainty around that level of interest rates. Even so, we still have some ways to go, and incoming data since our last meeting suggest that the ultimate level of interest rates will be higher than previously expected.
So even if the Fed transitions to a 50-bp rate hike in December, it may not mean that a rate pause is near. In the Q&A session, Fed Chair Powell tried to downplay any near-term transition to a pause in rate hikes:
So I would also say it's premature to discuss pausing. It's not something that we're thinking about. That's really not a conversation to be had now. We have a ways to go.
It’s not quite the “we’re not even thinking about thinking about” language that Fed Chair Powell used in 2020 when asked about rate hikes, but it’s similar, and it suggests that we have at least several more months of rate hikes of at least 50 or 25 basis points in size. Another 125 bps of rate hikes would increase the target federal funds rate to 5.00%-5.25%, which is close to the peak rate (5.25%) seen in 2006 and 2007 when online savings account rates peaked in the 5% to 5.50% range.
Once the Fed pauses on rate hikes, the next question is how long will the pause last. In 2019, the pause lasted just over seven months. Fed Chair Powell ended his opening remarks suggesting that we shouldn’t expect a quick pivot to rate cuts:
Restoring price stability is essential to set the stage for achieving maximum employment and stable prices in the longer run. The historical record cautions strongly against prematurely loosening policy. We will stay the course, until the job is done.
The Fed doesn’t want to repeat the 1970s when they didn’t stick with tight monetary policy to end high inflation, and that eventually forced the Fed, led by Paul Volcker, to hike rates to very high levels in the early 1980s.
Future FOMC Meetings
The next three FOMC meetings are scheduled for December 13-14, January 31-February 1, and March 21-22. The December and March meetings will include the Summary of Economic Projections (SEP).
Treasury Yield Changes
The Fed meeting didn’t have much impact on Treasury yields. Short-dated Treasury yields were down slightly today while long-dated yields were up slightly. The 2-year Treasury yield had the largest change, rising 7 bps to 4.61%.
The yield changes since the last Fed meeting are significant. Yields of all durations had sizable increases. The short-duration yields had the largest gains with the 1-month yield rising 111 bps, the 3-month rising 91 bps, and the 6-month rising 71 bps. The long-duration yields had smaller gains, but they were still sizable with the 30-year yield rising 75 bps, the 10-year yield rising 59 bps, and the 5-year yield rising 56 bps.
All Treasury durations except the 1-month now have yields above 4%. The 1-year yield is 4.76%, which is the highest yield of all durations. It might not be long before we see 5%.
In general, the Fed’s rate hikes are putting more upward pressure on short-dated Treasury yields than the long-dated yields. The result is a yield curve that is becoming more inverted. The spread between the 10-year yield and the 3-month yield (10y-3m spread) was positive after the last meeting (+20 bps). Now it’s negative (-12 bps). The spread between the 10-year yield and the 2-year yield (10y-2y spread) remains negative. Oddly, today’s 10y-2y spread equals the 10y-2y spread after the last Fed meeting (-51 bps). Historically, the more inverted the yield curve, the more likely that a recession follows within the next year.
The following yields are from the Daily Treasury Par Yield Curve Rates from the Treasury website.
- Sep 21 (last mtg) → Nov 1 → Nov 2
- 1-mo: 2.59% → 3.72% → 3.70%
- 3-mo: 3.31% → 4.23% → 4.22%
- 6-mo: 3.86% → 4.58% → 4.57%
- 1-yr: 4.08% → 4.75% → 4.76%
- 2-yr: 4.02% → 4.54% → 4.61%
- 5-yr: 3.74% → 4.27% → 4.30%
- 10y: 3.51% → 4.07% → 4.10%
- 30y: 3.50% → 4.14% → 4.15%
Future Deposit Rates
Online savings account rates have generally lagged the Fed rate hikes, and the lag has been greater than what we saw in 2018. The speed of this year’s Fed rate hikes may have contributed to this lag. If that is the case, we will likely see online savings account rates rise for some time after the last Fed rate hike until the top online savings account rates are close to the upper limit of the target federal funds rate. Both in 2006/2007 and in 2018/2019, top online savings account rates were close to the upper limit. If that does occur in 2023 and the target federal funds rate reaches around 5%, we should see top online savings account rates increase to near 5% in the first half of 2023.
The path of CD rates is more uncertain. Treasury note yields have often been early indicators of where CD rates are headed. Brokered CD rates are first to follow Treasury yields, and direct CDs from online banks and credit unions follow with some more lag.
Inflation and recession expectations drive long-dated Treasury yields more than Fed rate changes. As can be seen in the Treasury yield changes above, long-dated Treasury yields have risen since September even though they haven’t risen as much as the short-dated yields. You can see the bumpy path of 5-year Treasury yields this year in this chart that compares the yields of the average 5-year online CD to the 5-year Treasury note. If recession worries grow, these long-dated Treasury yields may fall back below 4%. If that happens, banks and credit unions may not be in a rush to offer new high rates on their CDs.
As I mentioned after the last Fed meeting, we may get to the point in which top online savings account rates are near or above the top CD rates. It’s going to be hard to justify locking into a long-term CD in this case. However, those who realize how fast savings account rates can fall, won’t dismiss CDs.
Strategies for Savers to Maximize Cash Yield
It’s hard to find CDs appealing when rates are rising fast. As I mentioned above, rates will eventually peak and then start falling. We should first see this decline in Treasury yields. That can give savvy savers time to lock into long-term CDs at relatively high rates. This condition occurred in 2019 before the first Fed rate cut and in 2020 before the emergency Fed rate cuts in March 2020.
CDs with Mild Early Withdrawal Penalties
Of course, you never can be sure if rates have peaked. To ease concerns, look for CDs with mild early withdrawal penalties (EWP). For long-term CDs, a mild EWP would be six months or less of interest. If rates do go higher, a mild EWP will make it less costly to close the CD and move the funds into an account with a higher rate.
No Penalty CDs to Boost Savings Account Yields
If you’re going to wait for rates to peak, liquidity will be important so that you can quickly fund a CD before rates fall. Online savings accounts, money market accounts and checking accounts with the highest rates would be best. You can sometimes get an additional boost in yields with little loss of liquidity by using no-penalty CDs. Today’s rate hike of Ally’s No Penalty CD is a good example. Ally customers can use the 11-month No Penalty CD to get an extra 60 bps of yield with very little loss of liquidity.
If you do use no-penalty CDs, just be sure to monitor the rates. If savings account rates rise above the no-penalty CD rate or if higher no-penalty CD rates become available, you should close the no-penalty CD and move that money.
Add-On CDs for Low-Rate Insurance
Another useful strategy is to acquire as many long-term add-on CDs as you can. Open these with just the minimum deposit. If rates rise well above your add-on CD rate, you can just let the add-on CD continue without additional deposits. With a small minimum deposit, this won’t cost you much. On the other hand, if rates do fall before the add-on CD matures, the value of the add-on CD grows as rates fall. In this case, the additional deposits into the add-on CD could earn you a lot more than opening a new CD. Long-term add-on CDs can be a great low-rate insurance policy, offering some protection against falling rates. Mountain America Credit Union just came out with higher rates on its CDs, including its add-on CDs (called Growth Certificates). The two best deals are its 24-month CD (4.50% APY) and its 60-month CD (4.00% APY).
Treasury Bills/Notes and Brokered CDs
Currently, Treasury bills/notes and brokered CDs have rate advantages over the vast majority of direct CDs. There are a few CD Specials which may have higher rates for a specific maturity. Treasury bills and notes also have some tax advantages and they can be easier to manage, especially in IRAs. The downside is an uncertain cost if you want to access the funds before maturity. Unlike direct CDs, there’s no fixed early withdrawal penalty.
Series I Savings Bonds
As I described in my Tuesday post on the new I Bond rates, new I Bonds will have a composite rate of 6.89%. This combines an inflation rate of 6.48% and a fixed rate of 0.40%. This I Bond fixed rate is a significant improvement over the 0% fixed rate that has been in effect since 2019. I Bonds that are purchased through April 2023 will earn an annualized yield of 6.89% for six months. The rate for the next six months will depend on inflation from September 2022 through March 2023. In mid-April 2023, we’ll be able to calculate the next I Bond inflation rate.
The main issue with I Bonds is that you’re limited to just $10k per year per SSN (plus $5k with your federal tax refund). I have more details on I Bonds in this post. There are ways to buy more I Bonds. This article at The Finance Buff describes how a married couple can buy up to $65k in I Bonds each calendar year via trust and business accounts.
Treasury Inflation-Protected Securities (TIPS)
TIPS bonds are an alternative to the I Bond. Like they I Bond, they provide inflation protection. Unlike I Bonds, there are no purchase limitations. The appeal of TIPS has gone up this year as their real yields have risen above 0%. Currently, the real yields are around 1.60% (see Daily Treasury Par Real Yield Curve Rates). Two useful resources on TIPS are this post by Harry Sit of The Finance Buff, and this Q&A on TIPS by David Enna of TIPSWatch.
Combination of All of the Above
It’s wise to remember that no one can accurately predict future interest rates. So if you want to keep things simple, a CD ladder of long-term CDs is always a useful strategy for your safe money. If you’re worried about being locked into a low-rate CD if rates should happen to rise, choose long-term CDs with early withdrawal penalties of no more than six months of interest. If you are concerned with rates rising very fast in the next year, keep more in online savings accounts and no-penalty CDs after you have maxed out what you can contribute to I Bonds.
For your safe money (with no risk to principal), a combination of I Bonds, TIPS, T-bills/notes, online savings accounts and CDs can still make sense.