Fed Meeting: Second Straight 75-bp Rate Hike - Strategies for Savers

At the conclusion of the FOMC meeting, the Fed announced its second straight 75-bp rate hike. The target federal funds rate is now 2.25%-2.50%, which is the target range that had existed at the peak of the last rate hiking cycle in December 2018. It took three years of rate hikes from 2015 to 2018 to equal the rate hikes from the last four and a half months. Below are excerpts from today’s FOMC policy statement that covers the rate decision:

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 2-1/4 to 2-1/2 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.

For the full details, please refer to today’s FOMC Statement.

The post meeting press conference provided some additional details about the Fed’s plans on future rate hikes. In prepared remarks, Fed Chair Powell described what it will take for the Fed to transition to smaller rate hikes:

Over coming months, we will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2 percent. We anticipate that ongoing increases in the target range for the federal funds rate will be appropriate; the pace of those increases will continue to depend on the incoming data and the evolving outlook for the economy.

There remains a question about how serious the Fed is about bringing inflation down. If we enter into a bad recession, the Fed will be under pressure to cut rates even if inflation is still above its target. However, Fed Chair Powell has stressed several times that bringing down inflation is the Fed’s highest priority:

We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses.

If the Fed is serious about bringing down inflation, the first rate cut should come several months after the last rate hike. If inflation doesn’t decline during this period, the Fed will probably extend the pause period.

Future FOMC Meetings

The next three FOMC meetings are scheduled for September 20-21, November 1-2 and December 13-14. The September and December meetings will include the Summary of Economic Projections.

Treasury Yield Changes

Treasury yields of all durations except for the 30-year declined today, suggesting that the market viewed the Fed’s meeting as dovish. From the last Fed meeting, short-dated Treasury yields increased substantially while long-dated yields declined. The Fed’s rate hikes are pushing up the short-dated Treasury yields while long-dated Treasury yields have fallen as recession worries grow.

The following yields are from the Daily Treasury Par Yield Curve Rates from the Treasury website.

• June 15 (last mtg) → July 26 → July 27
• 1-mo: 1.21% → 2.17% → 2.14%
• 3-mo: 1.74% → 2.55% → 2.44%
• 6-mo: 2.32% → 3.01% → 2.93%
• 1-yr: 2.93% → 3.06% → 3.00%
• 2-yr: 3.20% → 3.02% → 2.96%
• 5-yr: 3.38% → 2.89% → 2.82%
• 10y: 3.33% → 2.81% → 2.78%
• 30y: 3.39% → 3.03% → 3.03%

Future Deposit Rates

Online savings account rates have generally lagged the Fed rate hikes. It may take a while before the major online savings account rates reach the levels seen in early 2019 (the last time the fed funds rate was at 2.25%-2.50%). In early 2019, the average online savings account yield reached a high of 2.23%. The online savings account yields at Ally, Synchrony, Marcus and Discover reached 2.20%, 2.25%, 2.25% and 2.10%, respectively. With more Fed rate hikes likely for the rest of this year, it would seem likely that online savings account rates will soon reach and surpass those levels.

The path of CD rates is more uncertain. With recession worries growing and Treasury note yields falling, long-term CD rates may peak sooner than we would like to see. We are now seeing an inverted yield curve with short-dated Treasury yields higher than long-dated yields. A similar condition may occur with online CD and savings account rates. CD rates will likely not have a big advantage over online savings account rates. That will be a time when it feels wrong to lock into a long-term CD that has a yield similar to a liquid savings account. Those who realize that the savings account rates can fall quickly won’t dismiss CDs.

The 2022 rise of rates can be seen in the charts of the average online savings account rates and the average online 1-year and 5-year CD rates.

Rates will eventually peak and then start falling. The larger the economic downturn, the faster rates will fall. Treasury yield declines have been the first indication of falling rates. Banks and credit unions have typically been slower to react.

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.

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.

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. 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.

Treasury bills and brokered CDs are now good alternatives to short-term direct CDs. Longer-term direct CD yields have caught up to yields of Treasury notes and long-term brokered CDs. Treasury bills and notes 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

High inflation from September 2021 through March 2022 has resulted in a record-high I Bond inflation rate of 9.62%. Unfortunately, the I Bond fixed rate remains at 0%, so the composite rate equals the inflation rate. I Bonds that are purchased through October 2022 will earn an annualized yield of 9.62% for six months. The rate for the next six months will depend on inflation from March through September 2022. In mid-October 2022, we’ll be able to calculate the next I Bond inflation rate. There’s a chance that the I Bond fixed rate that will be announced in November will be positive for the first time since 2019. So you may want to wait until November to purchase I Bonds for 2022. With high inflation continuing, the I Bond inflation rate that will be announced in November should be high.

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.

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 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, online savings accounts and CDs can still make sense.