Rate Cuts Closer to a Reality; What to Do About It

It’s been nearly two years since I’ve last written about the Federal Open Market Committee’s (FOMC) forecasts. Yesterday’s updated projections warrant an update.

As has been widely discussed, the FOMC voted to leave interest rates unchanged. This was expected. Many Federal Reserve observers were looking for signs of rate cuts occurring during the second half of this year. They got it.

First, the meeting statement contained altered language about the committee’s intention regarding rate changes. The April/May meeting statement said, “the Committee will be patient as it determines” future adjustments to the federal funds rate. In contrast, yesterday’s statement said the Committee “will act as appropriate to sustain the expansion.”

Second, the dot plot changed. The dot plot—which is updated on a quarterly basis—charts the interest rate forecasts from each committee member. As you can see from the images on the right, the dots have been lowered. The central tendency range for fed funds rate (which excludes the three highest and three lowest forecasts) is now between 1.9% and 2.4%. In March—when the chart was last updated—the range was 2.4% to 2.6%. For 2020, the projected range is now 1.9% to 2.4% versus 2.4% to 2.9% three months ago. (Clicking on the charts will enlarge them.)

These changes move the dots in the direction we’ve been seeing priced into fed funds futures. The CME’s FedWatch Tool currently shows a 96% chance of interest rates being 50 basis points (0.50%) lower by the end of this year than they are now. The odds of rates being 75 basis points lower are currently at 65%. (These forecasts are very much subject to change.)

The bond market has been pricing in lower interest rates as well. The 10-year Treasury note closed today with a yield of 2.001%. To put the number in perspective, last November, the benchmark note yield was more than a full percentage point higher at 3.234%.

If you are a borrower, this is great news. If you’re a saver, it’s not. If you’re someone who made bets on bond yields rising sharply this decade, it’s a refutation. The bond market Armageddon some had previously called for is nowhere in sight. Rather, 3% continues to be a point of resistance for the 10-year note with only very brief periods of yields going modestly above this level occurring since the start of 2012.

As far as what you should do in response to all of this, the answer is not too much. The risks of making an error based on what you think might happen outweigh the risks of simply sticking to your long-term plan. Go back seven or eight years and look for forecasts calling for bond yields to be this low at the end of the current decade; good luck finding even one.

You can seek out higher interest rates on your cash savings. We have an affinity program with Discover Bank offering AAII members higher rates. If your cash is held in a brokerage account, review the options for sweep accounts and potentially for money market funds. On the bond side, laddering bond maturities can help offset interest rate risks. You can also ladder with defined-maturity bond funds; I’m working on an updated article about them. If you’re retired and are worried about what the FOMC’s lowered forecasts say about the economy, keeping a few years’ worth of planned withdrawals will help you weather any potential downturn in stocks. Our founder James Cloonan thinks keeping two to four years of retirement withdrawals in cash/safe short-term investments is a good idea regardless of what the Fed is doing.