How the Federal Reserve Affects Savings Account Rates
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When the Federal Reserve changes interest rates, consumers feel the ripple effects in all sorts of ways.
For savers, banks offering high rates tend to pay more when the US central bank raises rates and less when it lowers them. The Fed raised the target of federal funds rate six times so far in 2022 — lately 75 basis points in November – and it looks likely that rates will rise again in December.
“With the Federal Reserve raising interest rates to keep inflation under control, the outlook for savers has improved,” said Greg McBride, CFA, Bankrate’s chief financial analyst. “But where you have your money parked is really important. The best performing savings accounts and certificates of deposit remain the place to be because it is the banks that are increasing their payouts in an effort to remain competitive for savers’ money. But many banks – and especially the big banks – continue to be very stingy in passing on higher rates to savers.
For all who hope make savings a top priorityhere’s what to consider when the Fed changes the fed funds rate.
The Loose Link Between the Fed and Your High Yield Savings Account
Congress directs the Fed to maintain economic and financial stability. The central bank does this primarily by increase or decrease the cost of borrowing. Savings account rates are loosely tied to rates set by the Fed. After the central bank raises its rate, financial institutions tend to pay more interest on high yield savings accounts to remain competitive and attract deposits.
The two Fed cuts in March 2020 brought rates back to a range of zero to 0.25%. But Inflation at its highest in 40 years prompted the Fed to raise rates in March 2022 by 0.25 percentage points and in May by 0.5 percentage points. This was followed by rate hikes in June, July, September and November of 0.75 percentage points each. The 0.75 percentage point increases were the largest rate hikes since November 1994.
The ripple effects on your wallet don’t always hit right away. Online banks tend to compete for customers with relatively high rates, while physical banks tend to avoid paying savers competitive returns. Rates on savings accounts vary widely. Big physical banks, such as Chase and Wells Fargo, still pay around 0.01% APY, while best savings accounts offer about 3% APY, or 300 times more.
Escalating competition is one of the reasons for the disparity in returns. Online banks are looking to attract and retain deposits as fintech competitors continue to enter the market. Offering a high-yield account is one of the proven strategies to woo customers with an attractive offer, especially for relatively new and small digital banks.
Deposits, in general, are essential to banks’ business models: they are used as a source of low-cost funding to fuel demand for loans.
“Bankers don’t get deposits just because it’s cool to have deposits,” says Neil Stanley, CEO and founder of The CorePoint, a banking management services company. “They get them because they can invest them in loans.”
If the banks make money by investing the deposits in loans, then they can afford to pay more for the deposits. Spoiler alert: banks are (usually) profitable.
Not all banks are hungry for more deposits. Whether and when banks will react to the Fed’s rate change will vary depending on the goals they are trying to achieve.
“Each bank might be a little different on this in terms of pressures,” says Betty Cowell, senior adviser at consultancy Simon-Kucher & Partners.
What should savers do?
Although the average return on a traditional savings account is a paltry 0.16%, some banks offer high-yield savings accounts paying around 3% APY, or almost 19 times more. These accounts won’t do much to counter rising prices at the pump and grocery store, but they will help you earn something.
“High inflation and loss of purchasing power don’t negate the need for emergency savings,” says Bankrate’s McBride. “The main advantage of emergency savings It’s not the return you earn, it’s the immediate access to cash that protects you from costly debt or forced asset sales when unexpected expenses arise.
Online banks are known to offer the highest yields, but it’s worth shopping around. Also, consider cash management accounts and money market accounts to find the best deals. If you are able to park your money for a set period of time, consider a CD in the short term.
“For investors looking for predictable interest income, CDs will provide that and without the price volatility and default issues that many bonds have,” McBride says. “Don’t compromise your emergency savings to chase the yield of a CD unless the bank offers a way to cash in early without penalty if the money was needed.
When looking for the best deals, read the fine print about fees and minimum balances, and check that the account offers the features you need.
“If you’re a shopper in the market today,” says Simon-Kucher’s Cowell, “jump online and shop around and go with the brand you trust. »