Fed's Pause Has Begun - Rate Predictions & CD Strategies for 2019

There were no surprises yesterday when the Fed made its post-meeting statement. The federal funds rate remained the same, and the same patience language was used to describe the Fed’s future plans:

In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.

One thing that did change in the statement from January was the description of the current economic condition. There were clear downgrades in its view of the economy:

In January, the Fed’s statement included these positive views:

economic activity has been rising at a solid rate.

[...]

Household spending has continued to grow strongly

Yesterday’s statement changed the above lines to the following:

growth of economic activity has slowed from its solid rate in the fourth quarter

[...]

Recent indicators point to slower growth of household spending and business fixed investment in the first quarter

This policy action was an unanimous decision with no policymaker dissenting.

In addition to the statement, the Fed released an updated summary of economic projections (SEP). In the first table of this summary, you can see how the economic projections for future years show less growth than the December projections. For example, projected GDP numbers are down and unemployment rate numbers are up. PCE inflation numbers also went down, but the forecast core PCE inflation numbers did not change from December. These remained at 2.0%.

At the bottom of this first table, the forecast most interesting to savers is the projected federal funds rate. As expected, the median projected federal funds rate for 2019 and future years did go down from December. The median forecast for 2019 now indicates no rate hikes. This is down from two rate hikes that were indicated in December. Details about these federal funds rate projections are shown at the bottom of the SEP in the form of the “dot plot”.

There were two positive things to note from the dot plot. First, the median federal funds rate projections for 2020 do indicate one rate hike. So there is still a reasonable chance that Fed rate hikes are not over for this cycle. We may see at least one more rate hike in 2020. Second, no policymakers forecast a cut in the federal funds rate in the next three years. There was speculation that there would be at least one policymaker who would forecast a cut.

Lastly, Fed Chair Jerome Powell reinforced the message from the statement and in the SEP when he gave his press conference:

“We don’t see data coming in that suggest that we should move in either direction. They suggest that we should remain patient and let the situation clarify itself over time,”

In summary, we are now in a “pause” period. This is the first meeting that breaks the sequence of a rate hike after every other Fed meeting since the December 2017 rate hike.

Federal Funds Rate Futures

The federal funds rate futures as shown by the CME FedWatch Tool continue to show zero chance of a Fed rate hike in 2019. This has not change in the last couple of weeks. One thing that did change from Tuesday is an increased chance of a rate cut in 2019. The futures now show the odds of at least one rate cut by December to be 35.5%. Those odds of a rate cut have risen from 25.6% on Tuesday.

Future FOMC Meetings

The next three FOMC meetings are scheduled for April/May 30-1, June 18-19, and July 30-31. The June meeting will include the summary of economic projections. All meetings now include a press conference by the Fed Chair.

What Savers Should Expect in 2019

With the federal funds rate likely to hold steady for the rest of 2019, online savings account rates will also likely hold steady. The target range of the federal funds rate is 2.25% to 2.50%. This is the upper range of the current online savings account rates. The well-established internet banks like Ally and American Express have online savings account rates just below this range while the newer internet banks that are being more aggressive have rates that are in this range. These internet banks include PurePoint Financial, Rising Bank, Vio Bank and Citizens Access. We may see a few small rate hikes and rate cuts from the internet banks this year, but I doubt we will see the movement that we saw in 2018.

CD rates forecasting is more difficult. Several other factors in addition to movement (or lack of) in the federal funds rate impact this. One thing that tends to lead CD rate changes is changes in Treasury yields. Recent changes aren’t good news for savers.

The 10-year Treasury yield has dropped to a one-year low of 2.54%. The yield curve continues to flatten with several parts of the yield curve negative. For example, the one-month yield (2.45%) is now above the yields of the 5-year (2.34%) and the 7-year (2.44%). Fortunately, the 2-year yield (2.40%) is still under the 10-year (2.54%) with a 14 bps spread. When that spread goes negative, history has shown that a recession is likely to follow, and when there’s a recession, savings account and CD rates plummet.

With the Fed holding rates steady and with falling Treasury yields, there will likely be some downward pressure on CD rates. We have already seen this downward pressure in the last few months. First, Treasury yields declined in November as economic concerns grew. Then the brokered CD rates declined, and lastly, several direct CD rates declined.

Deposit Account Strategies

I think it’s very likely that we have either passed the peak of this rate cycle or we’re close to the peak. If the economy plays out as the Fed currently anticipates, we should only expect one more rate hike in 2020. If the Fed is too optimistic about the economy, it’s unlikely that we will see any more rate hikes for this cycle. In that case, the next move by the Fed may be a rate cut. Fortunately, there’s no indication that the Fed will rush to cut rates. It should take a big downturn in economic numbers to change the Fed. First, the Fed will change the language in its statements to suggest cuts are possible before it actually implements a rate cut. So we should have some time before we see any widespread deposit rate cuts.

Since we are likely at or near the rate cycle peak, I think it makes sense to look at long-term CDs. Many savers avoided these in 2018 as rates were rising. It’s no longer the time to avoid them. If you had suspended your CD ladders by not re-investing maturing CDs into new long-term CDs, it’s time to continue with your CD ladders by investing those funds back in long-term CDs.

There is still a slight chance that we are not close to the peak of this rate cycle. If you have any worry about being locked into a 5-year CD, make sure the 5-year CDs have early withdrawal penalties of no more than six months’ interest. In addition to reducing the risk of being locked into a CD as rates rise, it also gives you more flexibility to be able to use those funds for some other purpose that may arise in the future.

I’ve plugged in some top CDs into our CD Early Withdrawal Penalty Calculator so you can see how current competitive long-term CDs compare to competitive 1-year CDs when the 5-year CDs are closed early. The 1-year effective yields of the long-term CDs closed after one year are lower than the 1-year CD yield. The 5-year CD that has the highest effective 1-year yield when closed early is Ally Bank. With an EWP of 150 days, the effective yield is 1.81% at year one. That is 105 bps lower than Colorado Federal Savings Bank’s current 1-year CD rate (2.86% APY). If rates haven’t risen a year from now, and you hold on to that Ally 5-year CD, the effective yields grow. If rates rise by year two and it makes sense to close the 5-year CD, the effective yield of the Ally 5-year CD closed at year two will be 2.47%.

If you want to hedge your bets on future interest rates, it makes sense to go with a 5-year CD at Ally Bank or Colorado Federal Savings Bank. If you think the odds of any more rate hikes are too low, don’t worry about 6-month EWPs, and choose 5-year CDs with top rates like the 5-year Term Deposit at Mountain America Credit Union (MACU).

If you have CDs that won’t be maturing until later this year or next year, consider add-on CDs with long terms. Open the add-on CD now and you will lock in today’s CD rate until the CD matures. If rates fall by the time your current CDs mature, you can fall back on that add-on CD by making additional deposits into the add-on CD. Those additional funds will then begin earning that same CD rate that was set when the add-on CD was opened.

MACU offers add-on CDs that are called Term Deposit Plus accounts, and they have the same rates as their standard CDs (Term Deposit accounts). Unlimited additional deposits can be made, but there is one important limitation. The CD has a maximum balance of $100k.

The new internet bank, Rising Bank, offers two add-on CDs. These are called Rising CDs, and they have terms of 18 months and 3 years. For add-on CDs, the longer term ones are best for hedging bets on interest rates. The 3-year Rising CD currently has a 3.00% APY. Unfortunately, it has a high minimum deposit requirement of $25k. There’s a maximum balance of $500k, which is an important limitation to note. Another important limitation is that you are allowed to make no more than two additional deposits during the term of the 3-year Rising CD, and each deposit must be a minimum of $5k.

The 3-year Rising CD also provides two options to increase the rate if the 3-year Rising CD rate should happen to rise. I don’t consider that an important feature. It’s not clear in the CD disclosure, but I’ve been told by a Rising Bank official that this rising rate feature is completely independent from the add-on feature. In other words, you can exercise the add-on feature without the interest-rate feature. So if the CD rate falls, you don’t have to worry about your CD rate falling when you make the add-on deposit.