How the Fed affects credit cards

The Federal Reserve has made significant inroads in its fight against inflation. Given that progress, the Fed decided to drop its target interest rate for the first time in two years at its September 2024 meeting and has done so again at its November meeting. The quarter of a percentage point drop in November brings the target rate to 4.50 percent to 4.75 percent.

In a press release indicating its interest rate decision, the Federal Open Market Committee, the Fed’s rate-setting body, said it “judges that the risks to achieving its employment and inflation goals are roughly in balance.” That assessment led the committee to make its rate change, but said the economic outlook is still “uncertain” and did not indicate when additional cuts may come.

In considering future rate changes, the Committee “will continue to monitor the implications of incoming information for the economic outlook” and “would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals,” the press release notes.

Fed remains vigilant about inflation, but makes a rate decrease move

The Fed began a series of rate increases in March 2022, when inflation was at 8.5 percent, and has lifted up its target rate from 0 percent with a total of 11 rate hikes through July 2023. Since then, the Fed held rates steady until the drop at its September 2024 meeting.

Even though the rate hikes had the desired effect of bringing down prices, the Fed remains vigilant in its fight to maintain healthy inflation rates and low unemployment. In 2022, inflation — the rise in goods and services prices over a sustained period of time — was running at its highest level in more than 40 years. The Fed will not be complacent until it is convinced it has slayed the beast.

In 1980, inflation under Fed Chair Paul A. Volcker reached 11 percent. (At that time, the Fed’s rate hikes pushed the economy into recession, a scenario that hasn’t materialized this time around.) With that lesson in mind, the Fed is now focused on not bringing down its target rate without being certain it has quelled inflation, so that consumers and businesses don’t anticipate higher inflation down the road.

Pandemic-related effects led to inflation

The Fed’s series of rate hikes since March 2022 aimed to combat post-pandemic inflation. With supply chain disruptions and stimulus efforts provided during the pandemic, along with the impact of the war in Ukraine (which affected the price of oil and other commodities), stoking inflation, the Fed had been focused on raising its targeted interest rate to combat the fallout from inflation that proved to be stickier than the central bank expected.

After the coronavirus pandemic began in 2020, the Federal Reserve initiated cuts that brought down its target interest rate to practically 0 percent. That low rate was aimed at spurring consumption and business investment in order to keep the economy’s wheels greased as it recovered from the crisis.

The Fed also stepped in to purchase mortgage-backed securities and Treasury securities, which, too, had the effect of pumping money into the economy and lowering interest rates. It took additional measures as well to prevent financial markets from freezing up.

Now, in what is known as quantitative tightening, the Fed is also gradually shedding its balance sheet of the securities it acquired. This action will suck up money from the economy and further aid the Fed’s agenda by pushing up interest rates due to the reduced money supply. 

Employment and inflation goals

The Fed’s actions are guided by its dual mandate of managing both employment and inflation to optimize economic performance. Its aim is to shoot for maximum employment while letting inflation run at 2 percent in the long run, making for price stability.

Back in 2020, the Fed decided it would keep rates low — even as employment rose — to make the labor market more inclusive and allow even disadvantaged groups to get jobs, keeping in mind the lessons learned after the 2008 recession, when inflation did not rise even though employment continued to grow. It seemed the Fed would not start raising rates until 2023, but as inflation concerns surfaced, the central bank started its tightening cycle earlier in March 2022.

Considering that the pandemic-influenced inflation continues to linger and was further fueled by the war in Ukraine, the Fed is now focused on bringing inflation down so that expectations for higher inflation don’t get entrenched in the minds of consumers and businesses.

Further, even though rising interest rates have brought down inflation, the labor market remains strong. Employers added 12,000 jobs in October, while the unemployment rate remained low at 4.1 percent. In October, average hourly earnings were up 4 percent over the prior 12 months. Additionally, the government revised jobs numbers for August and September, which means 112,000 fewer jobs were added in those two months together than previously reported.

Consumers anticipate reduced inflation

On the inflation front, it seems consumers are not wedded to the idea that current high inflation levels will stick. A University of Michigan survey finds that in October, consumers expected inflation to be at 2.7 percent in the year ahead, which matches the rate from previous month.

Impact on credit card interest rates

What all of this means for cardholders is that you are likely to see your variable card interest rates remain at current high levels for a while even with the rate cut. Your credit card rates are tied to the prime rate, to which issuers add a markup to arrive at your card’s interest rate. The prime rate, in turn, is based on the Fed’s target interest rate. This means that when the Fed starts hiking its target rate — or dropping it — the prime rate responds in kind.

And when the prime rate moves, variable interest rates follow. In fact, interest rates on credit cards had been moving up over the last two years, before it started dropping again a few weeks ago. The national average APR was 20.39 percent in early November. When the target rate drops, cardholders can expect their credit card APRs to also drop slightly, but it won’t be enough to make a real difference if you’re working on paying off hefty credit card debt.

That means you should be managing your credit card balances strategically regardless of the Fed rate changes. If you carry a balance, make plans to pay it off. If you will be carrying a balance for a while, you could transfer it to lower-interest options, such as a balance transfer credit card with a 0 percent intro APR.

You might also consider taking out a personal loan to pay off your credit card if that offers a better deal for you. Home prices have been on a tear in recent years, and homeowners could even weigh getting a home-equity loan to pay off credit card debt. Another option would be to take on a side gig to earn additional income to pay off your debt.

The bottom line

While the Fed dropped its target rate to the 4.50 percent to 4.75 percent range at its November 2024 meeting, the central bank hasn’t yet declared victory in its fight against inflation just yet. It appears the Fed is done raising its target rate for now, but we don’t know whether the rate cuts will continue.

Since variable credit card interest rates are tied to the prime rate, which is based on the federal funds rate, consumers should be prepared for their variable interest rates to continue to remain at current high levels for some time even with incremental cuts. That means you should take strategic action if you carry credit card balances so that you pay the lowest interest rate you qualify for.