As expected, the Fed decided to hold its policy rate steady at its January 30-31 meeting. This is the fourth straight meeting with no rate changes. Below is the excerpt from today’s statement with the rate decision.
In support of its goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent.
A significant addition to the FOMC statement was a sentence that suggests that the Fed is in no rush to cut rates:
The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.
This should lower the odds of a rate cut at the Fed’s March 19-20 meeting.
Even though CPI and PCE data has shown cooling inflation, the strength of the economy has surprised the Fed. This was suggested in the first sentence of the FOMC statement:
Recent indicators suggest that economic activity has been expanding at a solid pace.
In the December FOMC statement, the opening sentence highlighted a slowing of the growth of economic activity. The strength of the economy is likely causing the Fed to be more careful about being too optimistic of the cooling inflation trend.
Yet again, all voting FOMC members voted in favor of today’s policy action. There was no voting member who dissented. The last time a member dissented was July 2022 when Kansas City Fed President, Esther L. George, dissented on the grounds that a 75-bp rate hike was too large.
The Summary of Economic Projections (SEP) was not updated for this meeting. Thus, there’s no update to the Fed’s dot plot. The dot plot of the December SEP had a median forecast for the target federal funds rate (TFFR) to be 75 bps lower by the end of 2024 (4.50%-4.75%), another 100 bps lower by the end of 2025 (3.50%-3.75%), and another 75 bps lower by the end of 2026 (2.75%-3.00%).
Wednesday CD Summary
Due to today’s Fed meeting and February starting tomorrow, I decided to postpone the CD Summary to Thursday. That will give me more time for the CD Summary, and it will allow me to include many of the new CD rates that several credit unions will likely publish for the new month.
More To Come
I plan to update this post later today with commentary on 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.
Comments that include politics unrelated to economics may be removed. Also, comments with any rudeness towards others will be removed.
Update: The following content was added at 5:45pm ET on Wednesday, January 31, 2023.
Post-Meeting Press Conference
In Fed Chair Powell’s opening remarks, there was no more mention of the possibility of further rate hikes. The sentence, “We are prepared to tighten policy further if appropriate,” was removed. However, the opening remarks didn’t open the door to rate cuts. There was an emphasis on playing it safe by maintaining the policy rate at its current level:
The economic outlook is uncertain, and we remain highly attentive to inflation risks. We are prepared to maintain the current target range for the federal funds rate for longer, if appropriate.
In the Q&A portion of the press conference, Fed Chair Powell was asked about the timing of the first rate cut, and he suggested that it’s unlikely to be at the March 19-20 meeting. Here are excerpts of his answer on the question of a March rate cut:
Based on the meeting today, I would tell you that I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting to identify March as the time to do that. [...] It’s probably not the most likely case, or what we call the base case.
This reinforced the addition in the FOMC statement that suggested that there’s a high bar for the first rate cut.
Of course, economic data in the next six weeks could change the minds of the Fed for a March rate cut. Fed Chair Powell described the economic conditions that would slow down or speed up the Fed’s move toward rate cuts:
There are risks that would cause us to go slower, for example, stronger inflation, more persistent inflation. There are risks that would cause us to go faster and sooner, and that would be a weakening in the labor market, or for that matter, very, very persuasive lower inflation.
”Higher for longer” made a comeback today. My guess now is that the Fed will hold steady through March. It seems likely that today’s target federal funds rate (TFFR) of 5.25%-5.50% will last until at least the Fed’s April/May meeting (April 30/May 1).
I’m still a little worried that high rates could end quickly if there’s another financial crisis or if a recession hits. The highly 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.
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 lower 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 4:40pm ET on 1/31/2024.
FOMC Mtg Date
Mar 19-20, 2024
Apr/May 30-1, 2024
Jun 11-12, 2024
Jul 30-31, 2024
Odds of a lower rate
Note that the odds are 100% of one or more rate cuts by the June meeting. In December, the odds of a March rate cut were 84.0%. It’s a good reminder to take these odds with a grain of salt.
Treasury Yield Changes
Before the Fed meeting, Treasury yields fell after New York Community Bank (the bank that acquired the failed Signature Bank last year) posted a quarterly loss and slashed its dividends. That triggered the market to worry about the banking sector and the possibility that it could contribute to sooner and larger Fed rate cuts. With the Fed pushing back on the March Fed rate cut, the yields recovered some, but the yields on durations from one year and longer declined today between 6 and 9 bps.
Since the last Fed meeting, yields are down substantially on durations from six months and longer. Since December 13th, the 6-month and 1-year T-bill yields have fallen 15 bps and 21 bps, respectively. The yield declines were less for the longer durations. The 2-year, 5-year and 10-year yields have fallen 19 bps, 9 bps, and 5 bps, respectively. The 30-year yield actually increased since the last Fed meeting; its yield has risen 3 bps.
The following yields are from the Daily Treasury Par Yield Curve Rates from the Treasury website.
- Dec 13 (last mtg) → Jan 30 → Jan 31
- 1-mo: 5.52% → 5.53% → 5.53%
- 3-mo: 5.44% → 5.42% → 5.42%
- 6-mo: 5.33% → 5.19% → 5.18%
- 1-yr: 4.94% → 4.80% → 4.73%
- 2-yr: 4.46% → 4.36% → 4.27%
- 5-yr: 4.00% → 4.00% → 3.91%
- 10y: 4.04% → 4.06% → 3.99%
- 30y: 4.19% → 4.28% → 4.22%
Future Deposit Rates
In the last two months, it seems like banks fully embraced the market’s view that Fed rate cuts were fast approaching. This was giving them reason to cut their CD rates to help their net interest margins (the difference between what banks receive from loans minus what they pay in deposits.) The best example of this is what Ally’s CFO described at Ally’s Q4 earnings call on January 19th:
we put in another set of rate reductions on the CD side this morning, our second so far in 2024. And so, we're definitely seeing some benefits already from the interest rate environment.
Perhaps today’s Fed meeting will slow or end this CD rate cut mentality by bank management. That may result in a slowdown of CD rate cuts in February.
Unlike CDs, we haven’t seen any significant savings and money market account rate cuts in the last few months. I expect that to last until the March meeting. If at the March meeting, the Fed opens the door to a May rate cut, we may then start to see early rate cuts on savings and money market accounts. Based on the 2019 history of the average online savings account yields, we are unlikely to see widespread savings account rate cuts until the Fed’s first rate cut actually takes place.
Strategies for Savers to Maximize Cash Yield
Does it make sense to delay buying CDs now that a March Fed rate cut appears unlikely? CD rate cuts may slow down a bit from what we saw in January, but I still don’t see any significant CD rate hikes at banks or credit unions. So I wouldn’t bet on higher CD rates anytime soon. That’s especially the case for long-term CDs. I still think the odds are high that 5% CDs and savings accounts will disappear later this year.
Of course, no one knows for sure how interest rates will evolve. Thus, it makes sense to hedge your bets.
CDs with Mild Early Withdrawal Penalties
A long-term CD is the best defense against falling rates. A mild early withdrawal penalty (EWP) helps protect against being stuck in a CD if rates go up considerably. 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.
One risk of depending on an early withdrawal is if the bank or credit union refuses to allow you to do an early closure. Many institutions do have disclosures that give them the right to refuse an early withdrawal request, regardless of the penalty. For example, BMO Alto’s CD disclosure has the following clause: “We reserve the right to permit withdrawals of principal only upon maturity.” Look for institutions that explicitly give the CD holder the right to make an early withdrawal. Barclays is one example. Its CD disclosure has the following clause: “You may, subject to an early withdrawal penalty, make withdrawals of principal from your CD Account before maturity.”
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.
Add-On CDs can be especially helpful if you’re waiting for a CD to mature. Open the add-on CD now, and when the CD matures, you can close the CD and use those funds to make an add-on deposit.
Unfortunately, there aren’t many add-on CDs. Also, most are short-term CDs which provide limited benefit as low-rate insurance. Those that are long-term often have rates lower than standard CDs with the same term. Lastly, some add-on CDs have limitations on the add-on deposits. They may only allow one or two add-on deposits, and there may be limitations on the size of the add-on deposit.
You can find a list of add-on CDs in the Add-On CD Section of the biweekly CD Summary.
The rate lock of a CD is especially important when rates are falling. No-penalty CDs provide a rate lock just like standard CDs, but funds in a no-penalty CD are much easier to access than a standard CD. The obvious benefit is the lack of an early withdrawal penalty. You can close the CD and you’ll receive all of the principal and all of the accrued interest up to the day of the closure.
No-penalty CDs do have some potential gotchas.
First, make sure all accrued interest will be included in the closure. One online bank that used to offer no-penalty CDs only included credited interest when an early closure was requested, and interest was only credited once per quarter. So if you requested a closure right before the end of the quarter, you could lose almost three months of interest.
Second, make sure that the process of requesting an early closure and receiving the funds is easy and quick. The best banks allow the closure request to be done via their online banking platform, and the closure and funds transfers can be done immediately for an internal transfer. This can be important if you might be using the no-penalty CD to fund a hot CD deal that could end quickly or if you have an emergency expense.
Third, make sure you understand the number of days after you open and fund the no-penalty CD before an early withdrawal is allowed. Regulations that govern CDs require banks to disallow early closures before seven days from CD opening. That is the typical early withdrawal limitation. However, some banks have longer wait times. For example, most of the no-penalty CDs available on the Raisin platform have a 30-day wait time before an early withdrawal can be requested.
Fourth, an early withdrawal typically will close the no-penalty CD. Partial early withdrawals are usually not allowed. So if you need to access just part of the principal, you’ll have to close the CD. If rates have fallen, you’ll lose the high rate that you had been earning.
It’s not a gotcha, but an unfortunate fact of no-penalty CDs is that they tend to be short-term CDs. For the standard no-penalty CD that allows a full penalty-free early closure at any time soon after account opening, there’s no downside of a longer term. In fact, the value of a no-penalty CD increases with a longer term. That’s especially the case when rates are falling.
Also not a gotcha but an unfortunate fact of no-penalty CDs is that they tend to have lower rates than standard CDs for the same term. In fact, they sometimes have rates that are lower than an online savings account from that bank. That will likely become more common as rates start to fall. Ally’s No Penalty CD rate (4.25% APY) has just recently fallen below its savings account rate (4.35% APY). Banks understand the benefit of a rate lock to the customer and will take that into account in the rates they set.
You can find a list of no-penalty CDs in the No-Penalty CD Section of the biweekly liquid account rate summary.
One alternative to no-penalty CDs is a savings account or money market account with a rate guarantee. These are typically better than no-penalty CDs since they don’t have the no-penalty gotchas that I described above. Unfortunately, these rate guarantees are rare, and the guarantee period is typically short. Currently, the best rate guarantee is being offered by Ivy Bank. It’s guaranteeing 5.30% APY until 6/30/2024 on its High-Yield Savings Account for balances up to $1 million. Note, these promotions often don’t last long when rates are falling.
One of the benefits of a CD ladder is that you don’t have to worry about interest rate changes. With a CD ladder, you just regularly reinvest maturing CDs into new CDs with the longest term of the CD ladder. If rates are rising, each new CD will benefit from the higher rates. If rates are falling, at least part of your funds will be in long-term CDs that have the higher rates before rates fell.