Fed Holds Rates Steady But Signals One More Rate Hike - Strategies for Savers

The Fed decided to hold rates steady at the end of its September 19-20 meeting. This was a widely expected decision. Before today, the odds that the Fed was going to hold rates steady had risen to the high 90s. This decision was also inline with the “every other meeting” rate hike strategy that the Fed appeared to put in place in June. Below is the excerpt from today’s statement with the rate decision.

the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy.

Some insights into the Fed’s future rate decisions can be seen in the Summary of Economic Projections (SEP) which includes the dot plot providing forecasts of the federal funds rate. In the June dot plot, 12 out of 18 FOMC members had forecasted a target federal funds rate (TFFR) of at least 5.50%-5.75% by the end of 2023. Today’s SEP shows 12 out 19 FOMC members forecasting this rate by December (since June a new Board of Governor member was added). Only 7 are forecasting that we have reached the terminal rate with the start of an extended pause.

One important change in the dot plot is the forecast for 2024. Today’s SEP shows that most of the FOMC members are forecasting no more than two rate cuts in 2024 (for a total of 50 bps). That would result in a TFFR of 5.00%-5.25% by December 2024.

Yet again, all voting FOMC members voted in favor of today’s policy action. There was no voting member who dissented.

More To Come

I plan to update this post later today with commentary on the SEP and the Fed Chair press conference. In addition, I’ll discuss my take on deposit account strategy in this environment. I just wanted to publish this initial post so that comments can begin.

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Update: The following content was added at 10:30pm EDT on Wednesday, September 20, 2023.

Summary of Economic Projections (SEP)

As I mentioned above, the most surprising change in today’s SEP was the higher projections for the 2024 federal funds rate. The median projected target federal funds rate (TFFR) by the end of 2024 is now 5.00%-5.25%. That’s up 50 bps from the June SEP. That suggests we’ll see a long pause that lasts through much of 2024.

With the Core PCE inflation for 2023 revised down from 3.9% to 3.7%, I was surprised that the median projected TFFR for 2023 remained at 5.50%-5.75%. I thought that might give FOMC members a reason to view an additional rate hike as unnecessary. Even though core inflation was revised down, the 2023 projected GDP was revised up by quite a lot, rising from 1.0% in June to 2.1% today. The 2024 projected GDP was also revised up, rising from 1.1% to 1.5%. Another sign that the economy is forecasted to be stronger is in the projected unemployment rates. Both the 2023 and 2024 projected unemployment rates were revised down. Stronger economic growth and a lower unemployment rate increase the odds that inflation won’t be falling towards the Fed’s 2% target. That appears to have been an important factor for the Fed revising its projections higher for the 2024 federal funds rate.

Post-Meeting Press Conference

In Fed Chair Powell’s opening remarks, he tried to emphasize that the fight against high inflation is far from over:

the process of getting inflation sustainably down to 2 percent has a long way to go. The median projection in the SEP for total PCE inflation is 3.3 percent this year, falls to 2.5 percent next year, and reaches 2 percent in 2026..

In the questions and answers session, a reporter asked Fed Chair Powell about inflation, and he said that the primary reason that rate hikes may not be over is stronger economic activity and consumer spending rather than persistent inflation. According to Fed Chair Powell,”

Broadly, stronger economic activity means we have to do more with rates,

The stronger economic growth is also contributing to higher yields of long-dated Treasurys. Fed Chair Powell was asked why long-dated Treasury yields have been rising. According to Fed Chair Powell, “rise in long-term yields is mostly not about inflation expectations, more about growth, supply of Treasurys.”

My Take

Based on today’s SEP, it looks like there’s a good chance that the federal funds rate will remain above 5% through 2024. Economic growth numbers are the latest drivers of “higher for longer”. If inflation surprises on the upside, that will only add to more “higher for longer” changes in the Fed’s future rate decisions. With oil prices rising and widespread strikes, it’s easy to see how inflation could surprise on the upside.

I’m still a little worried that “higher for longer” could end quickly if there’s another financial crisis or if a recession hits. The inverted yield curve is a sign that a recession will take place. The lag between the inverted yield curve and the start of the recession may be long, and that may be making it easy to dismiss the odds of a recession.

After experiencing two financial crises that have led to the Fed slashing rates to near zero, you learn not to take high rates for granted. High rates can disappear quickly in a financial crisis.

Next Four FOMC Meetings

The following table includes the dates of the next four FOMC meetings, whether they’ll include the Summary of Economic Projections (SEP) and the odds that the target federal funds rate will be higher than today’s target (5.25%-5.50%). These odds are based on the Fed Funds futures market via the CME FedWatch Tool as of 8:00pm EDT on 9/20/23.

It’s interesting to note that the highest odds of a higher rate is at the January meeting. The odds of a higher rate start to fall at the March meeting, but the odds are still close to 50%.

Treasury Yield Changes

The yields of Treasury notes (durations of 2 to 10 years) had the largest increase since the last Fed meeting. The 2-year, 5-year and 10-year yields increased 30 bps, 43 bps, and 49 bps, respectively. Treasury bill yields had mostly small changes since the last Fed meeting. The 1-month, 3-month and 1-year yields gained 7 bps, 5 bps, and 10 bps, respectively. The 6-month yield actually had a small decline, falling 4 bps.

At the post-meeting press conference, Fed Chair Powell was asked why long-dated Treasury yields have been rising. According to Fed Chair Powell, “rise in long-term yields is mostly not about inflation expectations, more about growth, supply of Treasurys.”

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

• July 26 (last mtg) → Sep 19 → Sep 20
• 1-mo: 5.46% → 5.53% → 5.53%
• 3-mo: 5.51% → 5.54% → 5.56%
• 6-mo: 5.55% → 5.51% → 5.51%
• 1-yr: 5.37% → 5.45% → 5.47%
• 2-yr: 4.82% → 5.08% → 5.12%
• 5-yr: 4.09% → 4.51% → 4.52%
• 10y: 3.86% → 4.37% → 4.35%
• 30y: 3.94% → 4.43% → 4.40%

Future Deposit Rates

The top online savings account rates should be close to the target federal funds rate (TFFR), which remains at 5.25%-5.50%. As I described in the liquid account summary today, there are currently 17 savings and money market accounts with APYs that range from 5.25% to 5.33%. All but two have APYs of either 5.25% or 5.26%. Banks and credit unions don’t seem to be moving toward the top range of the TFFR with their savings account rates. If the Fed hikes again in November or December, we should see a similar number of online savings and money market accounts with APYs around 5.50%.

It’s possible that 2024 could look like 2007. In the first half of 2007, the Fed was holding steady with a target federal funds rate of 5.25%. During this time, there were around 8 online savings and money market accounts with APYs that ranged from 5.30% to 5.50%. This included GMAC Bank (now Ally). Its money market account APY peaked at 5.30%. This was also the period when HSBC Direct and FNBO Direct offered a promotional 6% APY on their savings accounts.

Even with the federal funds rate being higher than it was in 2007, banks seem to be less rate aggressive than they were in 2007. That’s especially the case with the well-established online banks. Most of them are offering savings account APYs about a full percentage point below the federal funds rate. As of September 1st, the average online savings account yield was 4.39%. The average online savings account yield is based on the Online Savings Account Index, which tracks the average APYs of ten well-established online savings accounts.

Long-dated Treasury yields have been rising in September, and yields have risen to highs not seen since 2007. This rise has been impacting brokered CD rates, and it is slowly starting to impact direct CD rates. If this trend continues, it might not be long before we see several 5%+ long-term CDs.

Looking at the CD rate trend over the last two months, CD rates are trending up. The lists below show how the top 1-year and 5-year CD rates have changed. It includes top CD rates from banks, credit unions and from non-callable new-issue brokered CDs. For brokered CDs, the top 5-year CDs had the largest rate increase. For direct CDs, the top 1-year CDs had the largest rate increases.

Top 5-year CD rates from July 19 to Sep 20:

• Banks: 4.69% → 4.69%
• CUs: 4.84% → 5.00%
• Brokered CDs: 4.50% → 4.70%

Top 1-year CD rates from July 19 to Sep 20:

• Banks: 5.55% → 5.77%
• CUs: 5.50% → 5.80%
• Brokered CDs: 5.35% → 5.50%

Strategies for Savers to Maximize Cash Yield

Will this trend of rising long-term rates finally drive up long-term CD rates over 5%? It looks like we’re on track for that, but long-term rates have disappointed us several times over the last year.

Since you can’t know for sure how interest rates will evolve. One strategy is to hedge your bets for both rising and falling rates.

CDs with Mild Early Withdrawal Penalties

Since you can never be sure if rates have peaked, 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.

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.

Online Savings Accounts and No-Penalty CDs

For the cash you want to keep liquid or for cash that’s waiting to be used for CDs, Treasurys or other investments, it makes sense to keep that cash in the highest-rate savings or money market account. Just be sure that you can withdraw the funds fast so you can jump on deals that may come up.

The highest savings account rates are at the small online banks, but they often have weak ACH bank-to-bank transfer capabilities. The major online banks have much better ACH transfer capabilities, but their rates are far below the rate leaders. Look for major online banks that have high rates on their no-penalty CDs. CT Bank is a good example with its 11-month No Penalty CD that currently has a 4.90% APY. Except for the first six days, you can quickly close this CD without a penalty, move those funds into a liquid CIT Bank account, and use that money to fund a high-rate CD at CIT Bank or at another bank or credit union.

If you do open a no-penalty CD, make sure you monitor rates. If your online savings account rate rises above the no-penalty CD rate or if a new higher-rate no-penalty CD becomes available, it’s time to close the no-penalty CD and move those funds. If rates start to fall, the no-penalty CD will at least lock you in a rate for some time. The downside with most no-penalty CDs is that they have short term lengths. So the rate lock will be of limited value.

Treasury Bills/Notes

The rising yields of Treasury bills and notes have resulted in yield advantages over most CDs. A few of the top CDs still have an advantage. However, for non-special CDs at major online banks, Treasury yields are generally higher.

Treasury bills and notes have some tax advantages. Unlike CDs, they’re exempt from state and local income tax. To see how Treasurys compare with CDs when state income taxes are considered, you can use this useful Fidelity calculator.

In addition to these tax advantages, Treasurys held at one brokerage firm can be easier to manage than direct CDs held at multiple banks and credit unions. That’s especially the case for IRAs.

One downside of Treasurys is an uncertain cost if you want to access the funds before maturity. That requires selling the Treasury on the secondary market. Unlike direct CDs, there’s no fixed early withdrawal penalty.

Series I Savings Bonds

The May I Bond fixed rate was a pleasant surprise. At 0.9%, the new fixed rate is the highest it has been since 2007. This makes I Bonds purchased before November a good long-term deal. The 0.9% fixed rate will keep your rate of return above inflation.

The May I Bond inflation rate (3.38%) was much lower than last year, and when combined with the I Bond fixed rate, the composite rate for new I Bond purchases (4.30%) is a little disappointing when compared with current top 1-year CD rates. Unlike last year, new I Bonds don’t offer short-term gains that clearly outperform gains of top CDs.

The primary reason to buy I Bonds now is as a hedge against persistently high inflation, and that requires that you buy and hold the I Bonds for the long run.

An important 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 between 2.00% and 2.25%. On July 26, the real yields were between 1.50% and 1.85% (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. You can also ladder Treasury bills/notes and TIPS.

If you think rates have more room to rise, keep more in online savings accounts, no-penalty CDs, and/or T-bills.

For your safe money (with no risk to principal), a combination of I Bonds, TIPS, T-bills/notes, online savings accounts and CDs can make sense.