Fed Projections Show Zero Rates Through 2023 - Strategies for Savers

At the completion of its two-day FOMC meeting, the Fed announced a policy that’s inline with its new inflation strategy. In summary, the policy suggests that we won’t see a Fed rate hike for a long time, a period that's even longer than what was suggested at previous Fed meetings. The Fed also released updates to its Summary of Economic Projections (SEP) which includes federal funds rate forecasts that now extend out through 2023. Based on the FOMC statement and the SEP, it looks very unlikely that the Fed will hike rates through 2023. In fact, they suggest that the Fed may not hike rates for years after 2023.

First, here’s the important paragraph of today’s FOMC statement which includes the new inflation language that is used to describe the timeframe for how long the near-zero rates will last. I’ve highlighted the critical sections that specifically address the timeframe.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved. The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. In addition, over coming months the Federal Reserve will increase its holdings of Treasury securities and agency mortgage-backed securities at least at the current pace to sustain smooth market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses.

Two Fed policymakers voted against today’s policy. The FOMC statement included a paragraph describing their reasons for the dissent:

Voting against the action were Robert S. Kaplan, who expects that it will be appropriate to maintain the current target range until the Committee is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals as articulated in its new policy strategy statement, but prefers that the Committee retain greater policy rate flexibility beyond that point; and Neel Kashkari, who prefers that the Committee indicate that it expects to maintain the current target range until core inflation has reached 2 percent on a sustained basis.

Neel Kashkari is known as an inflation dove, and his dissent shows that he wants forward guidance that places a higher bar for the economy to reach (core inflation reaching 2% on a sustained basis) before the first rate hike. Robert Kaplan is known as a centrist, but his dissent today appears hawkish. He seems to want more flexibility for the Fed’s decision about the first rate hike.

Summary of Economic Projections (SEP)

Today’s SEP has changed considerably from the June SEP. One change is that the SEP now includes forecasts that extend out through 2023. The June SEP only included forecasts through 2022. The bad news for savers is that the large majority of Fed policymakers are anticipating no rate hike through 2023. None of the 17 policymakers anticipate a rate hike through 2021. Only one out of the 17 policymakers anticipates one or more rate hikes in 2022, and only four of the 17 anticipate one or more rate hikes in 2023.

More bad news for savers can be construed from the PCE forecasts. The PCE is the Fed’s preferred inflation measure. The median Core PCE projections of the 17 Fed policymakers is under 2% through 2022. It only reaches 2% in 2023. If the Fed sticks to its new inflation strategy and if inflation numbers move as the Fed anticipates, it could take several years after 2023 before the inflation numbers satisfy the Fed’s criteria that allows them to hike rates.

There is some good news that can be construed from today’s SEP. The economic recovery since June has been stronger than anticipated, and that’s indicated by the upgraded forecasts in the SEP. The forecasted unemployment rates for this year and the next two years have fallen considerably from June. By the end of 2022, the unemployment rate is forecasted to be 4.6%, that’s down from 5.5% in June. The GDP for 2020 was also upgraded. It’s now forecast to be -3.7%, that’s much better than the June forecast of -6.5%. If the economic recovery continues to outperform forecasts, it’s possible that inflation will rise faster than forecast, and that will force the Fed to hike rates sooner than expected.

Future FOMC Meetings

The next three FOMC meetings are scheduled for November 4-5, December 15-16, and January 26-27. The December meeting will include the summary of economic projections. All meetings now include a press conference by the Fed Chair.

Strategies for Savers to Maximize Cash Yield

Based on what the Fed has said and based on how deposit rates have fallen, I’m afraid we are in for a long period of very low deposit rates. Signs are that this zero-bound period will be worse than the zero-bound period from 2008 to 2015. Deposit rates have fallen much faster this time. For example, it took about 37 months after the Fed started its zero bound policy in December 2008 before Ally Bank’s online savings account yield fell to its pre-2020 low of 0.84%. It took only five months after the Fed started this new zero-bound period in March for Ally’s online savings account yield to reach a new low of 0.80%. And based on current savings account rates at Ally’s competitors like Marcus (0.60%), Barclays (0.60%) and PurePoint Financial (0.60%), we may soon see even lower rates.

The best hope for savers is that the economy does have a strong recovery in the next year. That will boost the stock market which will encourage investors to move their cash out of banks and into stocks. A strengthening economy will also boost loan demand which will force banks to increase their deposits. That leads to higher CD rates and more CD specials.

During the 2008-2015 zero-bound period, there were a few rare times when 3% CDs came out. The best example was in late 2013 and early 2014 when PenFed offered long-term CDs with yields just above 3%. Based on what we’re seeing with online CD rates in the last few months, I doubt we’ll see any 3% CDs in the next two years, but a few rare 2% CDs are possible, especially if the economy has a strong recovery.

With at least some possibility of 2% CD specials in 2021 and 2022, locking into long-term CDs with rates near 1% doesn’t seem like a good strategy. If we do start to see 2% CDs in 2021, it’ll be better to keep cash in online savings accounts and/or high-yield reward checking accounts. Then you’ll be able to jump on those CD specials when they appear.

There are still many reward checking accounts with yields of at least 2%. Of course, these have balance caps (typically $25k or lower) and monthly activity requirements to qualify for the high yield. Also, it’s likely we’ll see some rate cuts and balance cap reductions. However, many reward checking account rates held up fairly well during the 2008-2015 zero-bound period.

Long-term CDs now only make sense if we’re headed back into a long period of very low rates. In that case a 1% long-term CD will be better than a top savings account with a rate under 0.50%.

It’s wise to remember that no one can 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.