The Fed announced its first 50-bp rate hike since 2000 at the conclusion of its meeting today. In addition, the FOMC statement suggested that additional 50-bp rate hikes will be likely. The big news came from the post-meeting press conference when Fed Chair Powell downplayed the possibility of a 75-bp rate hike. That was interpreted by the markets as a dovish move resulting in a rally in the stock market. This didn’t help ease concerns that the Fed isn’t up to the job of controlling inflation.
Before reviewing the Fed Chair’s press conference, here’s the important excerpt from today’s FOMC statement that announced the first 50-bp rate hike since 2000:
the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent and anticipates that ongoing increases in the target range will be appropriate.
The FOMC statement also announced plans to reduce asset holdings. The balance sheet runoff is planned to begin in June with reductions ramping up to $95 billion per month after three months. This Quantitative Tightening (QT) is the opposite of Quantitative Easing (QE), and this QT process will take money out of the financial system which should put upward pressure on interest rates. The announced QT plan was inline with expectations.
Unlike the last meeting, no FOMC participants dissented. In the last meeting St. Louis Fed President James Bullard dissented. Instead of a 25-bp rate hike, he had wanted a 50-bp rate hike. By not dissenting at today’s meeting, it can be assumed that James Bullard didn’t see the need for a 75-bp rate hike.
Fed Chair’s Press Conference
As I mentioned above, Fed Chair Powell downplayed the chance of a 75-bp rate hike at upcoming meetings. When asked about a 75-bp rate hike, Fed Chair Powell said the following:
75 basis point increase is not something the committee is actively considering.
Fed Chair Powell did signal that we should expect at least two more 50-bp rate hikes:
50 basis point increases are on the table at the next two meetings
Fed Chair Powell was also asked about how inflation and unemployment data will impact the Fed’s decisions on the size of the rate hikes. Fed Chair Powell emphasized that it will take more than one month of data to change the Fed’s direction. As an example, he cited the core PCE inflation numbers from the last two months that showed slight improvements. The committee will want to see more significant improvements before it changes course.
Based on what Fed Chair Powell said today, it seems likely that the Fed will hike 50 bps at both the June and July meetings. For the September meeting, the Fed will decide between rate hikes of 25, 50 or 75 bps based on how inflation and the economy have evolved. It will probably take significant upside surprises on inflation for the Fed to move to a 75-bp rate hike in September.
Fed Chair Powell was also asked about the neutral rate. The neutral rate is the theoretical federal funds rate at which the stance of the Fed’s monetary policy is neither accommodative nor restrictive. The Fed’s Summary of Economic Projections (SEP) has listed an estimated neutral rate that’s between 2.25% to 2.50%. In the press conference, Fed Chair Powell suggested a wider range for the neutral rate of 2% to 3%. That could lead the Fed to hike rates higher later this year to control inflation.
Future FOMC Meetings
The next three FOMC meetings are scheduled for June 14-15, July 26-27 and September 20-21. The June and September meetings will include the Summary of Economic Projections.
Treasury Yield Changes
Fed Chair Powell’s rejection of a 75-bp rate hike was viewed by investors as a dovish move in which the Fed may not hike rates as high as had been expected. That put downward pressure on Treasury yields this afternoon. Most Treasury yields declined today. By the time the market closed, the 1-year yield was down 9 bps (2.07%), the 2-year yield was down 12 bps (2.66%), and the 5-year yield was down 8 bps (2.93%). Even though the yields were down today, yields have risen considerably since the March Fed meeting.
The following yields are from the Treasury website.
- Mar 16 (last mtg) → May 3 → May 4
- 1-mo: 0.24% → 0.48% → 0.49%
- 3-mo: 0.44% → 0.91% → 0.89%
- 6-mo: 0.86% → 1.45% → 1.44%
- 1-yr: 1.35% → 2.16% → 2.07%
- 2-yr: 1.95% → 2.78% → 2.66%
- 5-yr: 2.18% → 3.01% → 2.93%
- 10y: 2.19% → 2.97% → 2.93%
- 30y: 2.46% → 3.03% → 3.01%
Future Deposit Rates
As Treasury yields have surged this year, brokered CD rates have been the first deposit rates to experience a large rise that paralleled Treasury yield gains. Direct CDs at online banks and credit unions were the next deposit product to experience rate gains. Online savings account rates have been the slowest to rise. With today’s 50-bp rate hike and with at least two additional 50-bp rate hikes likely to take place in June and July, I expect a big acceleration of online savings account rate hikes and a moderate acceleration of CD rate hikes. As we get closer to peak rates, CD rates will likely not have a big advantage over online savings account rates.
Rates will eventually peak and then start falling. The larger the economic downturn, the faster rates will fall. Treasury yield declines have been the first indication of falling rates. Banks and credit unions have typically been slower to react.
Strategies for Savers to Maximize Cash Yield
CD rates are rising faster than online savings account rates, but it’s hard to find CDs appealing when rates are rising fast. As I mentioned above, rates will eventually peak and then start falling. We should first see this decline in Treasury yields. That can give savvy savers time to lock into long-term CDs at relatively high rates. This condition occurred in 2019 before the first Fed rate cut and in 2020 before the emergency Fed rate cuts in March 2020.
If you’re going to wait for rates to peak, liquidity will be important so that you can quickly fund a CD before rates fall. Online savings accounts, money market accounts and checking accounts with the highest rates would be best. You can get an additional boost in yields with little loss of liquidity by using no-penalty CDs. If the rate peak is a year or more away, you may be able to boost your yields by using some conventional CDs. Make sure the CDs have mild early withdrawal penalties and the bank or credit union allows quick early closures of the CDs and a quick transfer of the funds.
Treasury bills and notes and brokered CDs are now good alternatives to direct CDs. Direct CD rates, even at online banks and credit unions, are not keeping up with Treasury yield gains. In addition, Treasury bills and notes have some tax advantages and they can be easier to manage, especially in IRAs. The downside is an uncertain cost if you want to access the funds before maturity. Unlike direct CDs, there’s no fixed early withdrawal penalty.
Series I Savings Bonds
High inflation from September 2021 through March 2022 has resulted in a record-high I Bond inflation rate of 9.62%. Unfortunately, the I Bond fixed rate remains at 0%, so the composite rate equals the inflation rate. I Bonds that are purchased through October 2022 will earn an annualized yield of 9.62% for six months. The rate for the next six months will depend on inflation from March through September 2022. In mid-October 2022, we’ll be able to calculate the next I Bond inflation rate.
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.
High-Yield Reward Checking Accounts
Reward checking accounts have a small-balance issue that’s similar to I Bonds. High rates only apply to balances that typically range from $10k to $25k. Unlike I Bonds, you have to be willing to do the work to earn the high yields on the reward checking accounts by meeting the debit card usage requirements. There are a few reward checking accounts (some with linked savings accounts) that do offer high rates on larger balances. These rates can be much higher than the average online savings account rate, and the balances can be between $100k and $200k. In December, I published this post with a list of these reward checking/savings combos that offer high yields on large balances.
One downside with reward checking is that their rates tend not to increase as fast as online savings account rates during rate-hiking cycles. Thus, as rates rise, the advantage of reward checking over online savings accounts diminish.
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. If you are concerned with rates rising very fast in the next year, keep more in online savings accounts after you have maxed out what you can contribute to I Bonds and reward checking accounts.
For your safe money (with no risk to principal), a combination of I Bonds, reward checking accounts, online savings accounts and CDs can still make sense.