Fed Meeting: Downshift to 25-bp Rate Hike - Strategies for Savers

At the conclusion of the FOMC meeting this afternoon, the Fed announced a 25-bp rate hike. This follows a 50-bp rate hike in December and a 75-bp rate hike in November. It’s interesting to note that the Fed has ramped down its rate hikes like it ramped up rate hikes early last year. That suggests this might be the last Fed rate hike, but it’s too early to make that call.

This downshift to a 25-bp rate hike was highly anticipated after the inflation reports over the last two months that have indicated inflation is starting to ease.

The target federal funds rate is now 4.50%-4.75%. This is now 225 bps above the peak of the last rate hiking cycle (2015-2018). We haven’t seen federal funds rates this high since late 2007. The last time the Fed increased the target federal funds rate to 4.75% was in March 2006. During this period, the target was a specific rate rather than a 25-bp range.

Below are excerpts from today’s FOMC Statement that covers the rate decision:

the Committee decided to raise the target range for the federal funds rate to 4-1/2 to 4-3/4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.

It’s important to note that the Fed is still saying that it “anticipates that ongoing increases in the target range will be appropriate.” That should help the odds of another rate hike in March.

Today’s FOMC statement was very similar to the December statement. Besides the higher rate, one important change was in the description of inflation. In the December statement, the Fed described inflation as follows:

Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.

This sentence was replaced with the following one in today’s statement:

Inflation has eased somewhat but remains elevated.

The fact that the Fed acknowledges that inflation remains elevated should also help the odds of another rate hike in March.

All voting members voted in favor of today’s policy action.

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.

Update: The following content was added at 9:17pm ET on Wednesday, February 1, 2023:.

Post-Meeting Press Conference

Fed Chair Powell continues to suggest that there’s a high bar for the Fed to start cutting rates. In his opening remarks, Fed Chair Powell had this to say about inflation:

The inflation data received over the past three months show a welcome reduction in the monthly pace of increases. And while recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path.

In the Q&A portion of the press conference, Fed Chair Powell was asked by WSJ reporter Nick Timiraos, “why not stop here and see what transpires in the coming months before raising rates again?” Part of Fed Chair Powell’s reply was as follows:

We’ve raised rates four and a half percentage points and we’re talking about a couple of more rate hikes to get to that level we think is appropriately restrictive. And why do we think that’s probably necessary? We think inflation is still running very hot.

Later in the Q&A session, Fed Chair Powell reinforced the notion that there was still a long way to go for the Fed before it could start rate cuts:

We’ve got a long way to go. It’s the early stages of disinflation [...] It has to spread through the economy, and it’s going to take some time. [...] If the economy performs broadly in line with those expectations, it will not be appropriate to cut rates this year.

Near the end of the press conference, Fed Chair Powell reiterated that rate cuts this year are unlikely. However, he did somewhat acknowledge that the markets might be right in the expectation that inflation will come down faster than the Fed currently expects, and that would open the door to a rate cut this year:

Given our outlook, I don’t see us cutting rates this year. [...] If we do see inflation coming down much more quickly, that will play into our policy.

It appears that if inflation generally follows the Fed’s forecasts, we’ll see at least two more 25-bp Fed rate hikes with no rate cuts in 2023. If inflation falls more than what the Fed has forecasted (more in line with the market’s forecast), it’s possible that March may be the last Fed rate hike and a Fed rate cut will occur later this year. The apparent willingness of Fed Chair Powell to acknowledge this possibility made the markets happy this afternoon.

Future FOMC Meetings

The next three FOMC meetings are scheduled for March 21-22, May 2-3, and June 13-14. The March and June meetings will include the Summary of Economic Projections (SEP).

Treasury Yield Changes

Treasury yields fell after the Fed meeting. The long-dated Treasury yields had the largest declines. The 30-, 10- and 5-year yields fell 10 bps, 13 bps and 15 bps, respectively. The short-dated yields had little to no declines. The 1-, 3- 6- and 12-month yields fell 0 bps, 4 bps, 1 bp and 2 bps, respectively.

It’s also worth noting that long-dated Treasury yields are also down from the last Fed meeting. Short-dated yields are up significantly.

Since the Fed has more impact on short-dated Treasury yields, it makes sense that these yields have risen. The fall of long-dated Treasury yields can be attributed to market expectations on future inflation.

The yield curve continues to become more inverted. The spread between the 10-year yield and the 3-month yield (10y-3m spread) is now -127 bps. After the last Fed meeting, that spread was -84 bps. The 10y-2y spread has become slightly less negative since the 2-year yield has fallen more than the 10-year yield. The 10y-2y spread is now -70 bps. After the last Fed meeting that spread was -74 bps. Historically, the more inverted the yield curve, the more likely that a recession follows within the next year.

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

• Dec 14 (last mtg) → Jan 31 → Feb 1
• 1-mo: 3.91% → 4.58% → 4.59%
• 3-mo: 4.33% → 4.70% → 4.66%
• 6-mo: 4.68% → 4.80% → 4.79%
• 1-yr: 4.64% → 4.68% → 4.66%
• 2-yr: 4.23% → 4.21% → 4.09%
• 5-yr: 3.64% → 3.63% → 3.48%
• 10y: 3.49% → 3.52% → 3.39%
• 30y: 3.52% → 3.65% → 3.55%

Future Deposit Rates

Online savings account rates should be close to the target federal funds rate (TFFR). With the new TFFR now at 4.50%-4.75%, we should see more online savings account rates move into the high 4%. One has already reached 5% (5.03% APY at Primis Bank). In December, MySavingsDirect was the first to move into the TFFR range (4.25%-4.50%).

In the last month, we didn’t see many online savings accounts move into this TFFR range. The large online savings accounts were particularly disappointing, with most of them remaining far below this TFFR range. If that trend continues, we’ll likely see only a few online savings accounts in the new TFFR range (4.50%-4.75%) with the major online savings account rates struggling to surpass 4%.

I’m more pessimistic about CD rates. The December 50-bp Fed rate hike didn’t impact the top CD rates much. I compared the top rates from the December 7th CD summary to today’s CD summary. As you can see, most of the rates have fallen:

Top 5-year CD rates from Dec 7th to Feb 1st:

• Banks: 4.75% → 4.59%
• CUs: 4.60% → 4.80%
• Brokered CDs: 4.05% → 3.70%

Top 1-year CD rates from Dec 7th to Feb 1st:

• Banks: 5.00% → 4.85%
• CUs: 4.86% → 4.76%
• Brokered CDs: 4.80% → 4.75%

The only increase was the top 5-year CD rate at credit unions. With the smaller rate hike today, it seems that CD rates will more likely fall than rise in the next six weeks.

Strategies for Savers to Maximize Cash Yield

If we don’t get any upside inflation surprises, it’s hard to see what could drive long-term CD rates higher. Short-term CD rates may rise a bit higher, but based on the last six weeks, I doubt we’ll see widespread increases.

I think it’s likely that long-term CD rates have peaked. It’s still easy to get long-term direct CDs with rates over 4%. For brokered 5-year CDs, 4%+ rates are already gone. It might not be long before 4% long-term direct CDs are gone.

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. There’s already one online savings account with a yield over 5% (It’s the Primis Bank savings account with a 5.03% APY). Several other online savings and money market accounts have yields well over 4%.

It’s important to remember that these high yields will fall quickly once the Fed starts to cut rates. Some of the ones offering the highest rates may fall even before the first Fed rate cut. No-penalty CDs can be useful if rates start to fall. They can also be useful to provide a boost to your online savings account rate. Just make sure you monitor the 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 you plan to use the money in the online savings account or no-penalty CD to fund a standard CD, make sure that you can withdraw the funds fast and without dollar limitations. The new/small online banks offering the highest rates often have weak ACH bank-to-bank transfer systems.

Treasury Bills/Notes

The yields of Treasury notes no longer have a rate advantage over top direct CDs. However, Treasury bills (with terms of one month to one year) have yields that are closer to the top CD yields. There are a few CD Specials which have higher rates than T-bills for similar maturities. For non-special CDs at major online banks, T-bill 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

I Bonds continue to be a good deal with a current composite rate of 6.89%. This combines an inflation rate of 6.48% and a fixed rate of 0.40%. This I Bond fixed rate is a significant improvement over the 0% fixed rate that has been in effect since 2019. I Bonds that are purchased through April 2023 will earn an annualized yield of 6.89% for six months. The rate for the next six months will depend on inflation from September 2022 through March 2023. In mid-April 2023, we’ll be able to calculate the next I Bond inflation rate. I Bonds may lose their appeal if inflation falls.

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.

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 1.14% and 1.33%. Six weeks ago, the real yields were between 1.30% and 1.39% (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.