Unlocking Savings: How the Fed Shapes Your Interest Rates!

December 25, 2024

0 4 minutes read

Unlocking Savings: How the Fed Shapes Your Interest Rates!

When the Federal Reserve tweaks interest rates, it sends shockwaves through the economy, touching every consumer in ways you might not expect. For those stashing away cash, a hike in rates usually means higher returns from banks—while a cut can see those rates drop like a rock.

In a recent decision, the Fed voted to lower rates by a quarter of a percentage point, bringing the federal funds rate down to a range of 4.25-4.5 percent.

Earlier this fall, the Fed slashed rates by a total of 75 basis points over its last three meetings due to signs that inflation was letting up and the job market was showing cracks. This followed a stern period where rates were hiked 11 times in just two years, pushing the federal funds rate to heights not seen in over two decades.

“While interest rates are set to decrease as the Fed adjusts benchmark rates, savvy savers should still scout out top-yield savings accounts that still offer returns surpassing inflation,” explains Greg McBride, CFA, Bankrate’s chief financial analyst. “Finding the right account can mean the difference between keeping your head above water and getting swept away by rising prices.”

If you’re serious about transforming your savings game, let’s break down what you need to know when the Fed adjusts interest rates.

The Unseen Connection: Fed Rate Changes and Your Savings Account

It’s the Fed’s job to keep the economy humming, and they do that mainly by raising or lowering borrowing costs. The interest rates on savings accounts don’t directly mirror these shifts, but they’re certainly influenced. After a rate hike, banks often boost interest on high-yield savings accounts to attract more deposits. Conversely, when the Fed cuts rates, banks tend to lower their offers as well.

In the wake of the COVID-19 pandemic, the fed funds rate plummeted to a historic low of 0 to 0.25 percent. However, soaring inflation led the Fed to increase rates by a whopping 4.25 percentage points in 2022 alone. And in 2023, four more hikes of a quarter-point each followed. Fast forward to September 2024, and rates were once again trimmed to a range of 4.5-4.75 percent.

As inflation currently hovers around 2.7 percent—slightly rising after a downward trend—many banks have been slashing their deposit account rates this year. Yet, competitive deposit accounts are still offering yields that are historically high.

Online banks are leading the charge to attract customers with better rates, while traditional brick-and-mortar institutions lag behind, offering as little as 0.01 percent annual percentage yield (APY). In contrast, the best high-yield savings accounts can yield up to 4.85 percent APY—485 times greater!

This fierce competition is driving the discrepancy in rates. Online banks, eager to attract deposits, are rolling out enticing offers—especially as fintech players flood the market. Providing high-yield accounts is one of the best ways to win over customers, especially for newer digital banks.

Deposits are the lifeblood of banks; they provide a low-cost source of funding for loans.

“Banks don’t just collect deposits because they like having money on hand,” says Neil Stanley, CEO of The CorePoint. “They gather these funds to invest in loans.”

When banks earn money from loaning out deposits, they can afford to pay higher interest to savers. And guess what? Banks are generally quite profitable.

However, not every bank is on the hunt for more deposits. The timing and extent to which banks react to the Fed’s changes can vary based on their unique goals. Online banks are typically quick to respond to Fed rate hikes, while established brick-and-mortar banks may not match these increases for their savings accounts.

“Every bank operates under different pressures, and their responses will reflect that,” notes Betty Cowell, a former senior advisor at Simon-Kucher & Partners.

Maximizing Your Savings Rate

While the average yield on a standard savings account sits around a meager 0.57 percent, some banks are offering high-yield options that exceed 4.65 percent APY—over eight times more!

“Emergency savings are essential for immediate access to cash, shielding you from costly debt or forcing you to sell assets unexpectedly. Fortunately, online savings accounts are not only safe but also yield returns that outpace inflation,” asserts McBride.

While online banks generally offer the best rates, shopping around is crucial. Don’t overlook cash management accounts and money market accounts for solid deals. If you can keep your cash parked for a while, short-term CDs could also be worth exploring.

“Now is the time to lock in attractive yields and predictable interest income with CDs, without the price volatility and default risks that many bonds carry,” advises McBride. “Just make sure you don’t sacrifice your emergency savings for higher yields in a CD unless the bank offers an early withdrawal option without penalties.”

The Fed’s interest rate decisions profoundly shape how millions of Americans approach saving and investing. “When rates rise, there are opportunities to build wealth through high-yield savings accounts and CDs. But when rates drop, many seek more flexible options that keep their money working without locking them into lower returns,” says Gabe Krajicek, CEO of Kasasa. “Consumers need to stay informed and adaptable, balancing growth with access to their funds.”

As you sift through banking options, keep these pointers in mind: