Federal Reserve Impact on Savings Account Interest Rates

When the Federal Reserve changes interest rates, consumers feel the ripple effect in many ways.

For depositors, banks offering the highest interest rates tend to pay more when the US Central Bank raises interest rates and pay less when they lower them. The Fed raised its federal funds rate target by 25 basis points today after raising the target seven times in 2022.

Bankrate’s Chief Financial Analyst, CFA Greg McBride said: “But where you keep your cash really matters. But many banks, especially the big ones, continue to be very stingy in passing higher interest rates onto depositors.”

For those who want to make saving money their number one priority, here are some things to consider when the Fed changes the federal funds rate.

A loose link between the Fed and high yield savings accounts

Congress mandates that the Fed maintain economic and financial stability. Central banks mostly do so by raising or lowering the cost of borrowing money. Interest rates on savings accounts are loosely linked to interest rates set by the Fed. After the central bank raises interest rates, financial institutions tend to pay more interest on higher-yielding savings accounts to stay competitive and attract deposits.

Two Fed rate cuts in March 2020 put rates in the range of zero to 0.25%. However, the highest inflation in 40 years has forced the Fed to raise rates by 4.25% in his 7th annual meeting in 2022. These included his four 0.75 percentage point gains, the largest rate hike since November 1994. Today’s rate hike is the smallest since March 2022, and with inflation starting to slow, further rate hikes this year are likely to be modest as well.

The ripple effects of rate hikes may not hit your wallets right away. Online banks tend to compete for customers with relatively high interest rates, while brick-and-mortar banks tend to avoid paying depositors competitive yields. Savings account rates vary widely. Large traditional banks such as Chase and Bank of America still pay about 0.01% per annum, while top high-yield savings accounts offer more than 4% per annum, or 400x more.

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Increased competition is one of the causes of yield disparity. Online banks are working hard to attract and retain deposits as fintech competitors continue to enter the market. Offering high-yield accounts is one proven strategy for acquiring customers with compelling offers. Especially for smaller digital banks that are relatively new.

Deposits are generally integral to a bank’s business model. Deposits are used as a low-cost source of funding to facilitate financing demand.

Neil Stanley, CEO and Founder of Corepoint, a bank administration services company, said: “They can invest in loans, so they get them.”

If a bank makes a profit by investing deposits in loans, it can pay more for deposits. Spoiler alert: Banks are (usually) profitable.

Not all banks are hungry for more deposits. Whether and when a bank responds to his Fed rate change depends on what the bank is trying to achieve.

Betty Cowell, Senior Advisor at consultants Simon-Kucher & Partners, said:

What savers should do

Traditional savings accounts have an average yield of just 0.23%, but some banks offer high-yielding savings accounts that exceed 4% of APY. That’s nearly 20 times more. These accounts aren’t very useful for combating high prices at pumps and grocery stores, but they can help you earn something.

“High inflation and loss of purchasing power do not negate the need for emergency savings,” says McBride. “The primary benefit of emergency savings isn’t just the return you get, it’s the immediate access to cash to protect yourself from high debts and forced asset sales in the event of unplanned expenses.” .”

Online banks are known to offer the best yields, but they cost money to shop with. Also consider cash management and money market accounts to find the best deals. If you can hold cash for a period of time, consider a short-term CD.

“For investors looking for predictable interest income, CDs provide that, without the price volatility and default concerns that many bonds have,” says McBride. “Don’t sacrifice emergency savings for CD yields unless your bank offers a way to cash out early without penalty if you need the money.”

When looking for the best offers, read more about fees and minimum balances to make sure your account offers the features you need.

“If you shop in today’s market, compare prices online and choose brands you trust,” says Cowell of Simon-Kucher.