The Fed decided to lower rates again. As expected, the target range of the federal funds rate was reduced 25 bps to 1.75% to 2.00%. We are now down 50 bps from the recent peak of the target range for the federal funds rate. It should be remembered that we never had two rate hikes at two consecutive Fed meetings in the last rate hiking cycle. This current pace of rate cutting is twice the rate hiking pace that we experienced, and that is without any indication that the economy is nearing a cliff. Those who have advocated for big rate cuts should keep that in mind.
The following is an excerpt of today’s FOMC statement with the all important rate cut description:
In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 1-3/4 to 2 percent.
The rest of today’s FOMC statement was close to the July statement with a very similar economic overview. One significant difference was the number of voting dissenters. There were three dissenters this time rather than two in July. Like the July meeting, two committee members (Esther L. George and Eric S. Rosengren) voted against the policy action because they wanted to hold rates steady. However, there was another member (James Bullard) who voted against the policy action because he wanted a larger rate cut of 50 bps.
Summary of Economic Projections
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 the Fed’s economic projections for future years and how they compare to the Fed’s June projections. For GDP and the unemployment rate, there were slight upgrades. There were no changes in inflation projections. With forecasts like these, you can see why there was no large rate cut.
Fed’s Dot Plot
At the bottom of this first table, the forecast most interesting to savers is the projected federal funds rate. The median projected federal funds rate for 2019 shows no more rate cuts. That’s also the case for 2020. In 2021, the median projection is for one 25 bp rate hike. That’s also the case for 2022. By the end of 2022, the median projection for the federal funds rate is 2.4% which would require two 25 bps rate hikes from today.
It should be noted that a median projection that suggests no rate cuts for 2019 should not be taken too seriously. If you look at the projections of the participants in the bottom most chart of the SEP, you’ll see there are three groups in the committee. One group of 5 projects one 25 bp rate hike by the end of 2019. One group of 5 projects no more rate changes, and one group of 7 projects one more 25 bp rate cut. If those 7 are the voting members, there will likely be another rate cut in 2019 if economic conditions don’t change. In 2020, the rate hike group and the rate cut group grow. For future years, the rate hike group grows while the rate cut group shrinks. Out of the 17 participants, 10 of them think the federal funds rate will be higher (by 25 to 75 bps) by the end of 2021. That’s a reasonable optimistic view of future rates in two years that savers should keep in mind.
In the press conference, Fed Chair Jerome Powell was asked several times about the path of future rates. He downplayed the need for large rate cuts as long as the U.S. economic outlook remains favorable. Fed Chair Powell said to reporters that “if the economy does turn down, then a more extensive sequence of rate cuts could be appropriate.” According to Fed Chair Powell, today’s rate cut was intended “to provide insurance against ongoing risks.” In his opening remarks, he gave the following description of the risks:
Since the middle of last year, the global growth outlook has weakened, notably in Europe and China. Additionally, a number of geopolitical risks, including Brexit, remain unresolved. Trade policy tensions have waxed and waned, and elevated uncertainty is weighing on U.S.investment and exports.
One reporter asked about the dot plot and how that should be interpreted. Fed Chair Powell stressed that the dot plot should not be taken too seriously since future economic data may change projections considerably. In short, the odds of future rate cuts are probably higher than what they appear based on the dot plot.
Lastly, there was discussion at the press conference about the Fed’s response to elevated funding pressures in money markets this week. The markets appeared to be pleased to hear Fed Chair Powell mention that “it is certainly possible that we’ll need to resume the organic growth of the balance sheet sooner than we thought.” Any increase in the balance sheet could put downward pressure on long-term yields just like Quantitative Easing did. However, Fed Chair Powell tried to downplay the impact of the Fed’s action in this area by saying that “while these issues are important for market functioning and market participants, they have no implications for the economy or the stance of monetary policy.” This Barron’s article has a detailed review of this topic.
Federal Funds Rate Futures
The Fed Funds futures markets (via the CME FedWatch Tool) are now pricing in a 44.9% chance of another Fed rate cut in October. The odds of the Fed holding rates steady are 55.1%. That’s a good sign that rate cuts could be ending sooner than many expect. By the end of the year, the odds that the federal funds rate will be at least 50 bps lower (125-150 bps) are now 12.6%. That’s just a little higher than yesterday’s odds (11.4%).
Future FOMC Meetings
The next three FOMC meetings are scheduled for October 29-30, December 10-11, and January 28-29. The December 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 and 2020
Online Savings Account Rates
Online savings account rates have remained near the target range of the federal funds rate. 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 at the top of this range.
With the new target range of the federal funds rate being 1.75% to 2.00%, we should expect online savings account rates to move down by about 25 bps.
The online banks didn’t wait for a Fed rate cut. When the Fed opened the door to rate cuts at its June meeting, several online banks responded with cuts on their online savings accounts. These included Ally, Synchrony, Marcus by Goldman Sachs, Barclays and Discover. Since the time from the first rate cut on July 31st, these well-established internet banks have further cut their rates by 10 to 20 bps. Most have savings account yields at or just below the previous bottom of the target range of the federal funds rate (2.00%).
As we have seen in 2019, CD rates can fall even when the Fed is holding rates steady. One thing that tends to lead CD rate changes is changes in Treasury yields, and Treasury yields have been on the decline since November. On November 8, 2018, the 10-year and 5-year Treasury yields were 3.24% and 3.09%, respectively. After the July Fed meeting, the 10-year and 5-year Treasury yields were 2.02% and 1.84%, respectively. Now, the yields are much lower at 1.80% and 1.68%. These are up from levels early this month. On September 4th, the 10-year and 5-year yields were 1.47% and 1.32%, respectively.
Brokered CD rates are the first deposit products that respond to Treasury yield changes. Like the Treasury yields, brokered CD rates have plummeted since November. The top 5-year brokered CD rate was 3.60% last November. As of last week, it’s down to 1.70%. That’s a fall of 190 bps.
Direct CD rates from online banks and credit unions haven’t fallen as much as Treasury yields and brokered CD rates, but we have started to see an increasing number of rate cuts, and the size of the rate cuts have been growing.
We should expect CD rates to keep falling until Treasury yields stop falling and the Fed signals an end to the rate cuts.
Deposit Account Strategies
Even though we are probably not heading into a long series of rate cuts, I think it’s likely that we’ll see at least one to two more Fed rate cuts in the next year. Even if trade tensions ease and the economy strengthens, the Fed is unlikely to return quickly to rate hikes. There will first be a long pause at the Fed to ensure the economy can handle higher rates. It seems doubtful that we’ll see any widespread CD rate increases in the next one or two years. Thus, mid-term and long-term CDs make sense now before we see more CD rate cuts. If you’re optimistic about the economy, choose mid-term CDs. If you’re pessimistic, choose long-term CDs. 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.
CDs with 3% yields still exist, but they have become harder to find. In fact, it’s very difficult to find any at banks. There are still a few credit unions that are offering them (like Navy Federal Credit Union), but I wouldn’t be surprised if these disappear in the next month.
5-Year CDs with Small Early Withdrawal Penalties
If you are worried about locking money into long-term CDs, look for 5-year CDs with early withdrawal penalties (EWP) of no more than six months of interest. A few online banks that have competitive 5-year CDs with EWPs like this include MainStreet Bank, TAB Bank, Ally Bank, Barclays, and PurePoint Financial. Unfortunately, all of the above banks have cut their 5-year CD rates in the last two months. To see how the EWP affects the yield when you close a CD early, please refer to our CD Early Withdrawal Penalty Calculator.
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.
Add-on CDs haven’t always worked as advertised. There have been a few credit unions that didn’t fully honor the add-on feature of their add-on CDs. If interest rates fall more than expected and the institution didn’t specify a maximum balance level, the risk increases that the institution may renege on its add-on deposit promise.
One add-on deposit 5-year CD that’s nationally available is the 5-year Growth Certificates at Mountain America Credit Union (MACU). Unfortunately, the rate fell last month from 2.70% APY to 2.50% APY. In late 2018, this rate had been as high as 3.51% APY. There’s only a $5 minimum initial deposit. The main downside to this add-on CD is a maximum balance of $100k (in any one or combination of Growth Certificate accounts). MACU allows members to add money to their Growth Certificates at anytime. The account also requires an automated monthly deposit of at least $10. The $100k maximum is a downside, but I think it increases the odds that you’ll be able to add deposits all the way to maturity.
A couple of online banks have add-on CDs, but they’re shorter-term CDs.
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 has a 2.35% APY as of 9/18/19 (Rate had been 30 bps higher in July). 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, especially in our current environment. 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 option without the interest-rate option. So if the CD rate falls, you don’t have to worry about your CD rate falling when you make the add-on deposit.
The online bank Bank5 Connect has been offering a 2-year add-on CD since 2013. The Bank calls it the 24-month Investment CD, and it has a 2.30% APY as of 9/18/2019 (Rate had been 40 bps higher in July.) According to the Bank5 Connect’s account disclosure for the Investment CD, “You may make an unlimited number of deposits into your account.” Minimum deposit is only $500.
With rates likely to fall, the no-penalty CD is a good way to avoid short-term rate reductions while maintaining liquidity. Unlike a regular CD, there’s no early withdrawal penalty. So there’s no lock on your money except for the first six days from account funding.
In the last year, no-penalty CDs have been introduced at a few online banks and credit unions. Ally Bank has been offering a no-penalty CD for years. Its current 11-month No Penalty CD has a 2.10% APY for a $25k minimum deposit (The rate had been 20 bps higher in July). Marcus at Goldman Sachs is one of the banks that has just recently introduced no-penalty CDs. The highest rate is currently 2.10% APY on a 7-month term. The no-penalty CDs with longer terms actually have lower rates (11-month earns 2.05% APY and the 13-month earns 2.00% APY). Remember when comparing these types of no-penalty CDs, longer terms are an advantage. The only reason to go for a shorter term is if the rate is higher.
The above rates are accurate as of 9/18/2019.
Return to Zero Rates?
There are two possible scenarios in how rates play out in the next few years. First, Fed rate cuts will soon end. The Fed’s economic projections are still favorable with no recession in sight. Once the Fed rate cuts end, there will likely be a period in which the Fed will hold rates steady, and once economic confidence returns, the Fed could return to rate hikes. This is the scenario that many on the Fed believe in, as shown in the dot plot.
The other possibility is that we are headed into a recession. The global economic slowdown and the trade tensions eventually bring down the U.S. economy. If that happens, it’s likely the Fed will lower rates back down to near zero, and we’ll return to the rate environment that we experienced between 2009 and 2015.
I don’t see any case in which rates rise quickly past where they were in late 2018. Of course, no one, including me, can predict future interest rates. Last year was a reminder of this when it appeared we might be seeing 4% savings account rates in 2019.