March 29th, 2020 11:15 AM by Jackie A. Graves
The central bank of the U.S. – also known as the Fed –
is charged by Congress with maintaining economic and financial stability. Mainly, it tries to keep the economy afloat by raising or
lowering the cost of borrowing money, and its actions have a great deal of
influence on your wallet.
Officials on the Fed’s rate-setting Federal Open
Market Committee (FOMC) typically meet eight times a year. The Fed looks at a
broad range of economic indicators, but most notably, it pays attention to
employment and inflation data. The Fed was scheduled to have its next
meeting this week on March 17-18. The meeting will no longer happen coming off
the Fed’s emergency cut.
The logic goes like this: When the economy slows
– or merely even looks like it could – the Fed may choose to lower interest rates. This
action incentivizes businesses to invest and hire more, and it encourages
consumers to spend more freely, helping to propel growth. On the contrary, when
the economy looks like it may be growing too fast, the Fed may decide to hike
rates, causing employers and consumers to tap the brakes on their financial
“When the Fed raises or reduces the cost of money, it
affects interest rates across the board,” says Greg McBride, CFA, Bankrate
chief financial analyst. “One way or another, it’s going to impact savers and
Even if you’ve only been tangentially following the
Fed, you’ve probably noticed that it’s been a bumpy past few months. Officials
cut interest rates three times in 2019, months after signaling to investors
that they’d intended to hike at least two more times. U.S. central bankers now
say they’re comfortable with waiting on the sidelines over the
next 12 months, as they wait for
evidence on just how much the three reductions impacted the economy.
Still, policy isn’t set in stone, and there’s a lot
that could happen over the next year that might yank the Fed in a different
direction. Here are five ways that you can expect the Fed to impact your
Most credit cards have variable interest rates, and
they’re tied to the prime
rate, or the rate that banks charge to
their preferred customers with good credit. But the prime rate is based off of
the Fed’s key benchmark policy tool: the federal funds rate.
In other words, when the Fed lowers or raises its
benchmark interest rate, the prime rate typically falls or rises with it.
“What the Federal Reserve does normally affects
short-term interest rates, so that affects the rates that people pay on credit
cards,” says Gus Faucher, chief economist at PNC Financial Services Group.
Leading up to the July rate cut, the prime rate was
5.50 percent, 3 percentage points higher than the top end of the fed funds
rate’s target range of between 2.25 percent and 2.5 percent. It typically stays
at that level — even as the Fed cuts rates.
By December, after the Fed’s three cuts were already
enacted, the prime rate had fallen by 75 basis points. That’s how much the Fed
reduced rates in total.
But credit card borrowers will be hard pressed to find
an interest rate that’s actually that low. After the Fed’s three cuts, average credit
card rates only fell slightly, to 17.36 percent from 17.8 percent, according to
Bankrate data that tracked rate changes between Sept. 4 and Dec. 18. In
reality, credit card rates are much higher because companies charge the prime
rate plus another margin that they determine themselves.
If you’re a saver, you’ll likely have the opposite
reaction of a credit card borrower. Savers benefit from rate hikes and take a
hit when the Fed decides to cut them.
That’s because banks typically choose to lower
the annual percentage yields (APYs) that they offer on their consumer products — such as
savings accounts — when the Fed cuts interest rates. For example, banks in June
2019 lowered their yields in anticipation of a rate cut.
But when and by how much banks choose to lower yields
after a rate cut depends on those broader conditions, as well as competition in
the space, McBride says. It’s also worth remembering that most high-yield
savings accounts on the market have annual returns that outpace inflation.
“If the Fed cuts rates, yields will fall, but you’re
still going to be far ahead from where you were a few years ago,” McBride says.
“Even if they unwind one of the nine rate hikes that they’ve made since 2015,
the top-yielding accounts are still going to be paying a rate above inflation.”
Yields on certificates of deposit (CD) generally fall when the Fed cuts rates as well, but
broader macroeconomic conditions also have an influence on them, such as the
10-year Treasury yield.
But individuals should focus on the inflation-adjusted
rate of return on CDs, says Casey Mervine, vice president and a senior
financial consultant at Charles Schwab. In the late 1970s, for instance, yields
on CDs were in the double digits; inflation, however, was as well. That means
consumers’ actual earnings were much lower, due to the erosion of their
If you’re worried about a Fed rate cut impacting your
returns, consider locking down a CD now.
“Sometimes people start lowering their rates in anticipation
of a cut,” says Katie Miller, senior vice president of savings products at Navy
Federal Credit Union. “That’s why I say, if you see some good CD rates, take
Mortgage rates aren’t likely going to respond quickly
to a Fed rate adjustment. Interest rates on home loans are more closely tied to
the 10-year Treasury yield, which serves as a benchmark to the 30-year fixed
That’s evident when you look into the past. Each time
the Fed has adjusted rates, mortgage rates haven’t always responded in
parallel. For example, the Fed hiked rates four times in 2018, but mortgage rates continued to edge downward in late December.
But even though the Fed has little direct control over
mortgage rates, both end up being influenced by similar market forces, McBride
“While not directly related to a Fed cut, the two are
sort of a reflection of the same concern: the expectation that the economy is
going to slow,” McBride says.
Right now, that’s been the fear about both the
domestic and global economy. U.S. hiring slowed in 2019, while manufacturing is
outright contracting. Growth around the world is also decelerating, and it’s
prompting many other central banks around the world to start cutting rates as
It’s highly likely that you’ll start to see those
long-term rates slip lower in tandem with short-term borrowing costs, Miller
“It’s long-term expectations that tend to dictate
where mortgage rates go more than short-term, but even long-term expectations
are getting a little bit lower here,” according to Miller. “You’ll probably see
mortgage rates come down as well. The more that comes down, the better off you
are, especially if you’ve gotten you a mortgage in the last couple of years.”
That means refinancing could be a smart option
for your pocketbook. A reduction in even just a quarter of a percentage point
could potentially shave off a couple hundred dollars from your monthly
“Mortgage debt tends not to be high cost; it’s just
high interest because of the value of the actual mortgage itself,” Miller says,
“which is why small changes in rates can make a big difference.”
However, if you have a mortgage with a variable rate
or a home equity line of credit –
also known as a HELOC – you’ll feel more influence from the Fed. Interest rates
on HELOCs are often pegged to the prime rate, meaning those rates will fall if
the Fed does indeed lower borrowing costs.
Modest Fed moves, however, likely aren’t going to
steer those rates in a drastic direction either, McBride says.
If you’re thinking about buying a car, you might see
slight relief on your auto loan rate. Even though the fed funds rate is a
short-term rate, auto loans are still often tied to the prime rate.
It might, however, be a modest impact. The average
rate on a five-year new car loan is 4.56 percent, down from 4.72 before the Fed
cut rates in July, according to Bankrate data.
When the Fed cuts rates, it’s easy to think of it as
discouraging savings, McBride says. “It’s reducing the price of money. It
incentivizes borrowing and dis-incentivizes savings. Essentially, it gets money
out of bank accounts and into the economy.”
On the other hand, a Fed rate hike discourages
borrowing, as the cost of money is now more expensive.
But that doesn’t mean it’s a bad time to save.
Building an emergency savings cushion,
and saving in general, is a prudent financial step.
“Good savings habits are important independent of the
interest-rate environment,” Miller says. “Your transmission in your car, if it
breaks, it doesn’t realize if rates are low.”
Stay ahead of any Fed rate moves by keeping an eye on
your bank’s APY. Regularly checking your bank statement can also help you
determine whether you’re earning a rate that’s competitive with
other options on the market.
If the Fed looks like it’s going to hike rates, paying
off high-cost debt ahead of time could create some breathing room in your
budget before a Fed rate hike. Use Bankrate’s tools to find the best auto
loan or mortgage for you.
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