6 key ways the Federal Reserve impacts your money

Did you buy a home when mortgage rates were at record lows in 2020? Did you job hop during the “Great Resignation” of workers in 2021? Have you been holding off on making a big-ticket purchase this year until you can find a cheaper deal and lower interest rate?

Believe it or not, those decisions might be linked to what’s happening at the world’s most powerful central bank: the Federal Reserve.

What does the Federal Reserve do?

The Federal Reserve is the central bank of the U.S., best known as the orchestrator of the world’s largest economy. The Fed has two main economic goals — price stability and maximum employment — and it uses interest rates as its main lever to accomplish those outcomes.

Cheaper borrowing costs can be the difference between businesses choosing to hire new workers or invest in new initiatives. Expensive rates, however, can cause both businesses and consumers to pull back on big-ticket purchases or hiring — worsening the job market.

High rates, however, can choke economic growth. Case in point: As the Fed holds interest rates at historic highs, unemployment has risen to the highest levels in three years, job growth has slowed from its rapid post-pandemic pace and workers are getting hired more slowly.

Those impacts illustrate why Fed officials are about to cut interest rates for the second consecutive meeting. With inflation now approaching the Fed’s 2 percent objective, officials don’t think they need to keep their key benchmark interest rate at the highest level in over a decade.

Officials have said they’re cutting interest rates to let up — at least somewhat — on how much they’ve been pressing on the brakes to slow the U.S. financial system. Yet, even with a rate cut, the price of borrowing money is still historically high.

The Fed’s next moves could have powerful implications for your wallet. Here are the six main ways the Fed’s interest rate decisions impact your money, from your savings and investments, to your buying power and job security.

1. The Fed’s decisions influence your borrowing costs

When the Fed’s interest rate falls, so, too, will the borrowing costs consumers pay — on everything from the cost of financing purchases with a credit card to car loans and personal loans.

That’s because the Fed’s key borrowing rate benchmark acts as a lever for other popular loan benchmarks, such as the prime rate and the Secured Overnight Financing Rate, or SOFR. In other words, when the Fed’s rate goes up (or down), those interest rates move in lockstep — a domino effect on broader consumer loan products.

Sometimes, rates even fall (or rise) on the mere expectation the Fed is going to adjust rates.

Still, two rate cuts will do little to change just how expensive borrowing costs have become thanks to the Fed’s forceful inflation fight. Here’s how much more expensive it’s become to finance various big-ticket items since the days when rates were holding at near-zero during the coronavirus pandemic:

After a rate cut from the Fed, borrowers often see rate adjustments reflected in one to two billing cycles — but only if they have a variable-rate loan. Consumers who locked in a loan with a fixed interest rate won’t feel any impact when the Fed raises rates.

Meanwhile, lenders will often adjust interest rates by a wider or smaller margin than the Fed’s benchmark interest rate depending on a variety of other factors — such as borrowers’ credit history or competition in the market.

“Banks are not required to line up their interest rates with the Fed’s rate,” says Liz Ewing, chief financial officer at Sapient Capital. “Each bank will respond to the Fed’s rate announcement and adjust rates in their own way.”

Mortgage rates have risen despite the Fed’s rate cut

Mortgage rates are the main exception. The 30-year fixed-rate mainly tracks the 10-year Treasury yield, rather than the fed funds rate. Both benchmarks are guided by the same macroeconomic forces, but at its most basic level, Treasury yields rise and fall due to investors’ expectations for inflation and economic growth, along with the public’s appetite for borrowing from the government.

Those forces can help explain why the key home-financing loan hasn’t behaved in parallel with the Fed. Since the Fed approved its larger-than-expected half-point rate cut in September, the 30-year fixed-rate mortgage instead increased by 68 basis points, according to Bankrate’s weekly national survey of lenders. That’s as the 10-year Treasury yield surged to the highest level since August as economic growth surprised to the upside.

Still, the 30-year fixed-rate mortgage is well below its peak:

2. Savings accounts and CDs mimic the Fed but will fall before the Fed cuts

Yields on savings accounts and certificates of deposit (CDs) have already started edging lower as the Fed has cut rates. The top 5-year CD is now paying 4 percent, down from 4.85 percent just last October. A 1-year CD, meanwhile, was offering a 5.75 percent APY back in December. That’s since fallen to 4.59 percent as of Oct. 30.

“Now is the time to lock in high-yielding CDs,” McBride says. “There is no advantage to waiting, as yields will trend lower as we get closer to the first Fed rate cut and accelerate further the longer you wait.”

A rate cut, though, won’t change what’s most important to savers: Yields are expected to continue topping inflation through maturity. They’re also bound to remain higher than they were in the aftermath of the coronavirus pandemic.

Case in point: The highest-yielding online savings account is offering an annual percentage yield (APY) of 5.05 percent, as of Oct. 30. That compares with an inflation rate of 2.4 percent, according to the Bureau of Labor Statistics. It’s also up from a 0.55 percent APY at the beginning of 2022.

The average savings yield remains more than seven times higher than it was when the Fed first started raising rates, rising from 0.08 percent to 0.57 percent as of Oct. 28, the highest in over a decade, according to national Bankrate data.

As always, online banks are able to offer more competitive interest rates because they don’t have to fund the overhead costs that depository institutions with physical branches have.

“Savers have enjoyed the best returns in more than 15 years on savings accounts, money markets, and certificates of deposit,” McBride says. “While returns will decline as interest rates fall, savers seeking out the most competitive offers will remain well ahead of inflation for the foreseeable future.”

3. With rates still high, it can be harder for borrowers to get approved for new loans

One of the reasons higher interest rates slow demand: They cut off households from the never-ending credit spigot. And as in the aftermath of three major bank failures, lenders may even become stingier about loaning money out — meaning getting approved for a loan could get harder, too.

A March Bankrate poll showed that half of applicants have been denied a loan or financial product since the Fed began raising interest rates two years ago. Americans with credit scores below 670 are finding it toughest to access credit.

The phenomenon reflects a key feature that’s likely to remain, even as the Fed cuts rates: Lenders sometimes grow pickier about who they lend money to, out of fear that they may not be paid back. Interest rates may climb even faster for borrowers perceived to be riskier. Financial firms may also fear that the risk of default is higher because monthly payments effectively become costlier when interest rates are high.

It also does some of the Fed’s work for it. Consequently, less access to credit leads to less spending — weighing on demand and taking some of the steam away from inflation.

“Tighter credit hits borrowers with less-than-stellar credit ratings the hardest – whether the borrower is a consumer, corporation, municipality or a national government,” McBride says. “The business of lending doesn’t stop but is instead more intensely focused on borrowers posing the least risk of default.”

4. The Fed’s rate decisions influence the stock market — meaning your portfolio or retirement accounts

A change in Fed policy can often cause some uncertainty for investors.

Stocks, for example, were volatile in the weeks leading up to the Fed’s September rate cut. The key S&P 500 index dropped 4.25 percent during the first week of the month, later followed by a 4 percent rebound in the week before the Fed’s September meeting.

Markets have been known to choke on the prospect of higher rates. Part of that is by design: Many investors reshuffle their portfolios away from stocks and instead toward traditional safe-haven investments — such as bonds or CDs — as yields rise. Those moves drain excess liquidity from the stock market.

It’s also because of worries: When rates rise, market participants often become concerned that the Fed could get too aggressive, slowing down growth too much and perhaps tipping the economy into a recession. Those concerns battered stocks in 2022, with the S&P 500 posting the worst performance since 2008 in the year.

On the other hand, cheaper borrowing rates often bode well for investments because they incentivize risk-taking among investors trying to compensate for lackluster returns from bonds, fixed income and CDs. Investors who’ve been worried about an economic slowdown may also find rate cuts a relief.

As the Fed grapples with what to do with interest rates, it’s important to keep a long-term mindset, avoiding any knee-jerk reactions and maintaining regular contributions to your retirement accounts. Falling stock prices also can create tremendous buying opportunities for Americans hoping to bolster their portfolio of long-term investments.

“Mom-and-pop investors should focus on the bigger picture: An economy that’s growing is conducive to an environment where companies will grow their earnings,” McBride says. “Ultimately, a growing economy and higher corporate earnings are good for stock prices. It just might not be a smooth road between here and there.”

5. The Fed has a major influence on your purchasing power

The Fed’s interest rate decisions are bigger than just influencing the price you pay to borrow money and the amount you’re paid to save. All of those factors also have a prevalent influence on your purchasing power as a consumer.

Low interest rates intended to stimulate the economy and juice up the job market can fuel demand so much that supply can’t keep up — exactly what happened in the aftermath of the coronavirus pandemic. All of that can lead to inflation.

High interest rates, meanwhile, are designed to weigh on inflation. Americans may decide to delay a purchase or investment that requires financing, weighing on consumer spending. Higher interest rates also can lead to joblessness if the economy slows too much. Without a paycheck, consumers have the least amount of buying power at all. The Fed is the country’s No. 1 inflation fighter because its tools are seen as the most effective.

This time, though, rate cuts are for different reasons than they were during periods like the Great Recession or the coronavirus pandemic, when officials were trying to stimulate growth. With the U.S. economy slowing but still stable, the Fed is seeking to calibrate interest rates with the strength of the financial system to avoid slowing down growth too much for too long.

Inflation has noticeably improved since surging to a 40-year high of 9.1 percent in June 2022. As of September, overall inflation is up 2.4 percent from a year ago, according to the Bureau of Labor Statistics’ consumer price index (CPI). The Fed’s preferred gauge — the Department of Commerce’s personal consumption expenditures (PCE) index — is showing an even cooler inflation rate of 2.1 percent for the month.

6. The Fed influences how secure you feel in your job or how easy it is to find a job

One of the biggest corners of the economy impacted by higher interest rates is the job market. Expansions that seemed wise when money was cheap might be put on the backburner. New opportunities made possible by low interest rates are no longer on the table.

The job market has clearly cooled since the Fed started raising interest rates. The nation’s joblessness rate has now held above 4 percent since May, currently hovering at 4.1 percent after hitting as low as 3.4 percent, Labor Department data shows. Employers have created about 132,000 jobs, on average, over the past six months, down from the prior six month’s 236,000 average pace. Meanwhile, companies are also dwindling their hiring plans, with the number of job openings on the market falling to 7.4 million in September, after soaring as high as 12 million in March 2022.

Since the Federal Reserve began raising rates in March 2022 about 1 in 5 workers say their employment or career situation has worsened (21 percent), according to Bankrate’s September 2024 Employment Security Survey. Nearly 3 in 10 workers (28 percent) say they are more worried now, Bankrate also found.

Layoffs are still historically low, but some industries have been tougher for jobseekers than others. Big tech firms including Meta, Amazon and Lyft laid off thousands of workers since the Fed started raising rates. Data from outplacement firm Challenger, Gray & Christmas shows job cuts nearly doubled in 2023 compared with 2022, hitting the highest total since 2009 when excluding pandemic-related layoffs. Job growth, meanwhile, is primarily driven by hiring in health care, social assistance and government, Bureau of Labor Statistics data shows.

“We do not seek or welcome further cooling in labor market conditions,” said Fed Chair Jerome Powell in an August address.

Bottom line

Raising interest rates is a blunt instrument with no method of fine-tuning specific corners of the economy. It simply works by slowing demand overall — but the risk is that the U.S. central bank could do too much. Put in the mix that officials are trying to judge how rates impact the economy with backward-looking data, and the picture looks even darker.

While the odds of a soft-landing have looked promising, eight of the Fed’s past nine tightening cycles have ended in a recession, according to an analysis from Roberto Perli, former head of global policy at Piper Sandler who now helps manage the U.S. central bank’s open-market operations at the New York Fed.

A higher-rate environment makes prudent financial steps all the more important, especially having ample cash you can turn to in an emergency.

Boosting your credit score and paying off high-cost debt can also create more breathing room in your budget in a higher-rate environment. Use Bankrate’s tools to find the best auto loan or mortgage for you, and shop for the best savings account to park your cash.

“Absent a complete about-face from the economy, interest rates aren’t likely to come down soon enough, or fast enough, to provide meaningful relief to borrowers,” McBride says.