What Do the Fed’s Rates Increases Mean for Savings Accounts?

How the Fed’s Interest Rate Increases Affect Savings Accounts in 2024 & Beyond

A steady stream of rate increases began in early 2022, a key Federal Reserve tool to keep the cost of goods and services in line. Rates remained high throughout 2023, but those increases may soon be coming to an end.

According to AP News, officials project at least three rate reductions in 2024.

What Is the Federal Funds Rate?

The federal funds rate is the Fed’s benchmark interest rate. It’s the target interest rate set by the Federal Open Market Committee. When someone says the Fed has raised interest rates — or lowered them — they’re typically talking about the federal funds rate. This is the base rate that banks charge each other for borrowing money overnight.

The FOMC is the only policymaking body within the Federal Reserve. It meets eight times a year and announces any changes to the target rate based on economic conditions. Raising interest rates is a strategy to control inflation while lowering interest rates is a strategy to end a recession.

These changes influence short-term interest rates on credit card balances and consumer loans. They can affect the amount of interest you earn on a savings account and on CDs. It also influences the performance of the stock market.

What Is the Relationship Between Interest Rates and Savings Account Yields?

Banks set their rates based on the federal funds rate. What interest rates a bank pays on savings accounts — or charges for loans — often change when the Fed raises or lowers the overall benchmark rate. Changes don’t happen overnight, but they eventually ripple through the economy.

“As the Fed raises its benchmark interest rate, banks and other financial institutions tend to follow suit, resulting in higher yields on savings accounts,” said Sophia Jones, an investment analyst for Canadian personal finance site PiggyBank. “However, savings account interest rates may not increase immediately or in lockstep with the Fed rate, and the size of the rate increase may vary from institution to institution.”

Banks constantly weigh the Fed’s shift and calculate how to shift the rates they offer. Their decision involves making a profit and remaining competitive with other financial institutions.

How Fed Rate Increases Impact Savings Account Interest Rates

The Fed began aggressively raising interest rates in March 2022 in response to the highest U.S. inflation rates in nearly 40 years. Banks followed suit, increasing their interest rates on savings accounts and CDs in the wake of each Fed hike.

Traditional savings accounts prior to the 2022 inflation surge were as low as 0.01% — but banks started raising rates for savings accounts in the years since. By 2024, the average rate was 0.45%.

Case Study

To understand how a Fed rate increase works its way to a personal savings account, let’s look at a hypothetical case of a savings account holder named Susan.

Susan has $10,000 in her savings account. Her account has a variable interest rate, meaning the interest rate changes when the federal funds rate shifts up and down.

The interest rate on her account is 0.5% — earning her $50 in interest every year.

The Fed announces a major rate increase. Her bank weighs the announcement and calculates how much to adjust its rates in response to the Fed’s move. 

Once the bank settles on new rates, it notifies Susan her new interest rate will be 1.5%.

Susan will now earn $150 in interest annually — three times as much as before the Fed increased the benchmark rate. 

What Savers Can Do to Take Advantage of Higher Interest Rates

When interest rates go up, it’s a good time to shop for the highest interest rates for your savings as part of your personal finance strategy. Higher interest rates make high-yield savings accounts and certificates of deposit — CDs — more attractive.

Both provide much higher returns than traditional savings accounts.

High-Yield Savings Accounts

High-yield savings accounts can offer interest rates more than 10 times the average rate for a traditional savings account.

They’re typically available through online-only banks. These institutions can offer higher yields because they don’t have to cover the overhead of traditional brick-and-mortar institutions.

With higher yields, you earn more interest over the course of a year. And with compound interest, you earn interest on your interest each day.

A traditional savings account offered an average 0.45% APY — or annual percentage yield — in 2024. That means if you had $10,000 in a traditional savings account, you’d earn about $45 interest over the course of a year.

But with the same balance in a high-yield savings account earning 4% APY, you’d earn $400 over the same period.

Certificates of Deposit (CDs)

If you don’t need access to the money in your savings for a few weeks, months or even years, you might consider a CD.

CDs typically offer better rates than high-yield savings accounts — but you have to purchase them for a specified period, usually three months to five years. The longer the term, the higher the rate of return. 

“If you need to take the money out before the CD matures, you pay a hefty penalty, such as forfeiting a portion of the interest that was earned,” Carey said. 

Shopping for CD rates is easy. You can buy them at banks, credit unions and most brokerage firms. And you can buy one online in minutes.

What Are the Downsides of Fed Rate Increases for Savers?

When creating a savings strategy, you need to factor in inflation. Higher interest rates may not keep up with inflation.

“This means if your savings account is earning a lower interest rate than the rate of inflation, you may actually be losing money in real terms,” Olivier Wagner told Annuity.org. Wagner is a CPA and founder of 1040 Abroad, a tax services firm for Americans living abroad.

High-yield savings accounts, CDs and other high-interest savings options should face less erosion from inflation, but they may not offer the best return for long-term savings.

“Investing in other assets such as stocks, bonds or real estate can be a way to hedge against inflation and potentially earn higher returns over the long term,” Wagner said.

While savers reap higher interest on their accounts, rising interest rates make business loans, car loans, mortgages and other loans more expensive. This can create a drag on business growth, slowing the economy and potentially causing unemployment.