When the Fed changes interest rates, consumers feel the ripple effects in different ways. For savers, banks offering the best interest rates tend to pay more when the U.S. central bank raises rates and pay less when it cuts them.
The Federal Reserve decided to cut interest rates by 50 basis points at its September meeting, effectively lowering the federal funds rate to a range of 4.75% to 5%.
The Fed had kept interest rates steady at its past five rate-setting meetings in 2024 and the final three in 2023. Prior to that, officials had raised rates a total of 11 times in 2022 and 2023, taking the federal funds rate to effectively its highest level in 23 years.
“Interest rates will fall as the Fed cuts its benchmark rate, but the highest-yielding savings accounts will continue to pay yields well above the targeted inflation rate,” says Greg McBride, CFA, chief financial analyst at Bankrate. “Seek out the highest-yielding savings accounts and they will continue to be the difference between staying ahead of inflation or lagging behind, as many banks, especially the larger ones, are not passing on much of their high interest rates to savers.”
For those who want to make saving money a top priority, here’s what to consider when the Fed changes the federal funds rate:
The loose connection between Fed rate hikes and high-yield savings accounts
Congress mandates that the Fed maintain economic and financial stability. The central bank does this primarily by raising and lowering borrowing costs. Interest rates on savings accounts are loosely tied to the interest rates set by the Fed. When the central bank raises interest rates, financial institutions tend to pay higher interest rates on high-yield savings accounts to remain competitive and attract deposits. Conversely, when the Fed lowers interest rates, banks tend to lower interest rates on savings accounts.
In March 2020, the federal funds rate was lowered to a range of zero to 0.25% in response to the COVID-19 pandemic. However, in response to the highest inflation in 40 years, the Fed decided to raise interest rates by 4.25 percentage points over seven meetings in 2022. In 2023, there will be a total of four 0.25 percentage point hikes. After keeping interest rates unchanged for the five meetings so far in 2024, officials have now decided to lower interest rates to a range of 4.75% to 5%.
Policymakers’ decision to cut rates comes as annual inflation has stabilized at 2.5% while the unemployment rate has soared to a three-year high. Some banks have lowered deposit rates in anticipation of the Fed’s rate cut, but yields on competitive savings accounts remain historically high for now.
Online banks tend to compete for customers with relatively high interest rates, while brick-and-mortar banks tend to avoid paying competitive yields to depositors. Savings account interest rates vary widely and are subject to change at any time. While large brick-and-mortar banks such as Chase and Bank of America still offer annual percentage yields (APYs) of around 0.01 percent, the top high-yield savings accounts offer APYs of up to 5.30 percent, which is a 530x return.
Increasing competition is one reason for the yield disparity: Online banks are struggling to attract and retain depositors as fintech competitors continue to enter the market. Offering high-yield accounts is one tried-and-true strategy, especially for smaller, newer digital banks, to lure customers with attractive offers.
Deposits are generally essential to banks’ business models and are used as a low-cost source of funds to stimulate loan demand.
“Bankers don’t just take deposits because they’re cool,” says Neil Stanley, CEO and founder of CorePoint, a bank management services company. “Bankers take deposits because they can invest those deposits in loans.”
If banks are making a profit by investing deposits in loans, they can afford to pay more for deposits. Spoiler alert: banks are (usually) making a profit.
Not all banks are hungry for more deposits. Whether and when banks respond to Fed interest rate changes depends on the goals they are trying to achieve. Online banks, which are often hungry for deposits, are more likely to follow suit if the Fed raises rates, but traditional brick-and-mortar banks tend not to respond to Fed rate hikes by raising their own savings rates.
“Different banks may be feeling a little bit of pressure,” said Betty Cowell, a former senior adviser to consulting firm Simon-Kucher & Partners.
How to Maximize Your Savings Rate
While the average yield on a traditional savings account is just 0.61 percent, some banks offer high-yield savings accounts that pay around 5 percent annual interest, or almost eight times the amount.
“The main benefit of emergency savings is that it gives you ready access to cash when unexpected expenses arise to protect you from high debt or being forced to sell assets, but online savings accounts still offer yields that beat inflation, so your emergency fund won’t become a drag on your portfolio,” says Bankrate’s McBride.
Online banks are known for offering the highest interest rates, but it’s worth shopping around. Also, consider cash management and money market accounts to find the best terms. If you can park your cash for a set period of time, consider a short-term CD.
“Now is a great time to get the predictable interest income that CDs offer without the price fluctuations and default concerns that come with many fixed income securities,” McBride says. “But don’t sacrifice emergency savings in pursuit of CD yields unless your bank offers a way to cash out early without penalty if you need the money.”
When searching for the best bank account for you, keep the following in mind:
- Compare APYs
- Read the fee fine print
- Understand minimum balance requirements
- Check if your account has the features you need
“If you’re shopping in the market today, compare prices online and choose a trusted brand,” Cowell said.
