Fed Says It’ll Be Patient on Rates - CD Strategies for 2019

As expected at the FOMC meeting, there were no changes in the federal funds rate. However, key language of the FOMC statement did change which sends a signal that the Fed will likely pause on rate hikes. The following sentence that was in the December FOMC statement is gone:

The Committee judges that some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective over the medium term.

The above sentence has been replaced in the January FOMC statement by the following:

In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.

All voting members voted for today’s policy decision. There were no dissents.

In addition to the change in the FOMC statement, the Fed issued a separate statement on balance sheet normalization. That too was looked favorably by the markets. The following is a key excerpt of that statement:

the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.

Fed Chair Jerome Powell’s press conference this afternoon reinforced the likelihood of a rate pause. In his opening remarks, he said:

the case for raising rates has weakened somewhat. The traditional case for rate increases is to protect the economy from risks that arise when rates are too low for too long, particularly the risk of too-high inflation. Over the past few months, that risk appears to have diminished.

The best chance that we will see one or more Fed rate hikes in the next year is if the economy stays healthy with continued improvements. Fed Chair Powell did say in his opening remarks that the outlook for the economy remains favorable even though risks have increased:

This change was not driven by a major shift in the baseline outlook for the economy. Like many forecasters, we still see “sustained expansion of economic activity, strong labor market conditions, and inflation near … 2 percent” as the likeliest case. But the cross-currents I mentioned suggest the risk of a less-favorable outlook.

Odds For a 2019 Rate Hike Plummet

The odds of a Fed rate hike sometime in 2019 plummeted after the meeting according to the Fed fund futures as shown by the CME Group FedWatch Tool. The odds that the federal funds rate will be higher by the September FOMC meeting are now 8.3%. This combines a 8.1% chance that the rate will be 25 bps higher and a 0.2% chance that the rate will be 50 bps higher. Yesterday, the odds were 23.3%. It’s clear that the market thinks the Fed has sent a message that they’re done with rate hikes.

Future FOMC Meetings

The next three FOMC meetings are scheduled for March 19-20, April/May 30-1, and June 18-19. The March and June meetings will include the summary of economic projections. All future meetings will have a press conference by the Chair.

Deposit Account Rate Predictions

As we saw in 2018, online savings account rates have followed the federal funds rates. We now have many online savings account yields between 2.00% and 2.50%. If the federal funds rate holds steady, online savings account yields will probably also hold steady.

Economic and inflation outlook are important drivers of long-term rates including CD rates. Concerns about the economic outlook have been driving CD rates lower in the last couple of months. For example, the top brokered 5-year CD rate in late November was 3.60%. That fell to 3.40% in early January. Yesterday, the top brokered 5-year CD rate was 3.15%.

Direct CD rates typically lag brokered CD rates. Thus, we haven’t seen widespread CD rate cuts at banks and credit unions. However, as I described in yesterday’s CD rates summary, several banks and credit unions that had been offering top 5-year CDs have made rate cuts in January. We may see more CD rate cuts over the next week since many credit unions make changes to their CD rates at the start of each month.

Deposit Account Strategies

I can’t say for sure, but it’s beginning to look more likely that we have already passed the rate peak of this cycle. It may be time to start moving money into long-term CDs. Many savers were hoping for the return of 4% CDs. We saw a few of them last year, but they didn’t last long. I doubt we’ll be seeing them for the foreseeable future. Currently, the top nationally-available 5-year CD rate is 3.63% APY (at Connexus Credit Union). My guess is that the top 5-year CD rate will be much lower a month from now.

Beware of overloading on short-term CDs. Since long-term CD rates aren’t much higher than short- and mid-term CD rates, the long-term CDs are a hard sell. However, when those short- and mid-term CDs mature, you may have to settle for much lower rates.

If you want to keep things simple for your safe money, CD ladders are a tried-and-true way to invest in CDs. The ladder ensures you take advantage of higher rates as interest rates rise. The ladder also ensures that you’re taking advantage of longer-term CDs that protect against falling interest rates. A few months ago, it seemed like we were a year or more away from peak rates. Now it looks like peak rates may have already passed. No one can predict future interest rates. A CD ladder is the best way to avoid having to play the interest rate guessing game.

There are a couple of strategies that can be helpful in this interest rate environment:

First, add-on CDs can be a great type of CD when there’s a significant risk of falling rates. The best add-on CDs for this case have long terms, small minimum deposits and large or unlimited add-on capability.

One attractive add-on CD that’s nationally available is the 5-year Term Deposit Plus account at Mountain America Credit Union. As of today, that CD has a 3.51% APY. Minimum deposit to open is only $5. It has a 5-year term, and add-on deposits can be made anytime as long as the CD balance does not exceed $100k. Also, automated monthly deposit of at least $10 is required. This 5-year add-on CD can be opened with just a $5 initial deposit and with $10 automatic monthly deposits. If rates fall, you can always fall back to this CD and add to the balance until the CD balance reaches $100k.

The second strategy is one that is well known to long-time DA readers. It’s choosing 5-year CDs with mild early withdrawal penalties (EWPs). If rates fall, you get the advantage of a CD rate that’s fixed for five years. If we get surprises in the economy that forces rates higher, you can always do an early withdrawal. With a mild EWP, the loss from the penalty won’t be too bad.

Using our CD Early Withdrawal Penalty Calculator, you can see what the effective yields would be on a CD when it’s broken early. For example, an Ally Bank 5-year CD that is opened today with a 3.10% APY would have an effective yield of 1.81% if the 5-year CD is closed early after one year.