5 Ways The Federal Reserve Impacts You | Bankrate

Did you buy a home in 2020? Did you job-hop in 2021? Did you hold off on buying a new car or home in 2022 until you can find a cheaper deal and lower interest rate?

Believe it or not, one institution impacts even the tiniest of your financial decisions: The Federal Reserve.

What is the Federal Reserve?

The Federal Reserve is the central bank of the U.S., one of the most complex institutions in the world. The Fed is best known as the orchestrator of the world’s largest economy, determining how much it costs businesses and consumers to borrow money. Cheap borrowing costs can be the difference between businesses choosing to hire new workers or make new investments. Expensive rates, however, can cause both businesses and consumers to pull back on big-ticket purchases — as well as hiring.

“Your job security, your portfolio, your debts and the direction of the economy are all subject to the Fed’s influence,” says Greg McBride, CFA, Bankrate chief financial analyst. “As that price of money changes, it ripples out in a lot of different directions. It impacts the health of the job market, the amount of money that’s flowing in the economy and the prices of assets at the household level.”

After raising interest rates a whopping 4.75 percentage points since March 2022, the Fed looks like it’s almost done making borrowing costs more expensive to cool red-hot inflation.

With one more rate hike on the table, borrowing costs and savings yields may soon hit their peak. In some cases, they could edge lower, depending on supply, demand and the economic outlook. The same deals borrowers grew used to in 2020 and 2021, however, are nowhere near, underscoring the importance of shopping around — even when the Fed steps to the sidelines.

Here are the five main ways the Fed impacts your money, from your savings and investments, to your buying power and job security.

1. The Fed’s decisions influence where banks and other lenders set interest rates

Higher Fed interest rates translate to more expensive borrowing costs to finance everything from a car and a home to your purchases on a credit card. That’s because key borrowing rate benchmarks that influence some of the most popular loan products — the prime rate and the Secured Overnight Financing Rate, or SOFR — follow the Fed’s moves in lockstep.

When interest rates are higher, the availability of money in the financial system also tends to shrink, another factor making it more expensive to borrow. Sometimes, rates even rise on the mere expectation the Fed is going to hike rates.

Case in point, here’s how much more expensive it’s gotten to finance various big-ticket items this year, after 4.75 percentage points worth of tightening from the Fed:

Source: Bankrate national survey data

After holding above 7 percent for three consecutive weeks, the average 30-year fixed-rate mortgage dipped to 6.74 percent by the end of 2022. Still, the more than 3 percentage point jump in a single year is unprecedented, McBride says.

Credit card rates, meanwhile, jumped to a record high of 20.04 percent on March 15. They’ve ratcheted even higher with every Fed rate hike, now hitting 20.23 percent as of April 26.

Consumers often see higher rates reflected in one to two billing cycles — but only if they have a variable-rate loan. If you pay off your credit card balance in full each month, higher interest rates won’t impact you.

Rates, however, climb at an even faster rate for borrowers perceived to be riskier, based on their credit history and score. Conversely, some lenders might offer better deals than others, simply to attract more customers in a competitive market.

“Borrowing costs tend to increase first after a Fed rate hike,” says Liz Ewing, chief financial officer of Marcus by Goldman Sachs. “Banks are not required to line up their interest rates with the Fed’s rate, so each bank will respond to the Fed’s rate announcement and adjust rates in their own way.”

And while mortgage rates generally follow the Fed, they can often — and quickly — become disjointed. Mortgage rates mainly track the 10-year Treasury yield, which is guided by the same macroeconomic forces. But at its most basic level, those yields rise and fall due to investor demand.

An inflation surprise helped send the 10-year Treasury yield surging past 4 percent last October, the highest since 2008. But on the flipside, two weaker-than-expected inflation reports sent yields tumbling at the end of 2022, while fear about more pain to come in the banking sector after two major bank failures weighed on the key yield even more. The 10-year Treasury yield has now fallen 82 basis points below its peak.

Investors bracing for a possible economic slowdown have sent the average 30-year fixed rate to 6.48 percent by April 26, according to Bankrate data.

Investors might pour more money into those safe-haven investments when the economy is expected to slow or contract, meaning mortgage rates might fall even if the Fed is raising interest rates. Longer-term yields, and consequently, mortgage rates, might also drop when the Fed is deep in the middle of an asset-purchase plan to lower longer-term rates, effectively making the U.S. central bank the biggest buyer in the marketplace.

2. The Fed’s rate acts as a lever for yields on savings accounts and certificates of deposit (CDs)

You might not be able to borrow as cheaply as you used to, but higher interest rates do have some silver linings, especially for savers: Banks ultimately end up increasing yields to attract more deposits.

The caveat, however, is yields hardly ever rise as fast or as high as the Fed’s interest rate. Traditional brick-and-mortar banks also hardly need the deposits, especially today.

The average savings yield over the past year has risen from 0.06 percent to 0.23 percent as of April 26, according to national Bankrate data.

Meanwhile, a 5-year certificate of deposit (CD) was paying an average 0.39 percent yield one year ago. Today, it’s offering an average yield of 1.23 percent.

But there are places where better payouts can be found, a search that’s becoming even more important for consumers amid high inflation. Those yields are at online banks, which 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.

A big example: The 14 banks ranked for Bankrate’s best high-yield savings accounts in July 2021 were offering an average yield of 0.51 percent, with a high of 0.55 percent and a low of 0.40 percent. At the time, that was about nine times the national average.

As of April 28, the 10 banks ranked for April 2023 are offering an average yield of 4.5 percent, nearly 20 times the national average and 450 times offerings at Chase and Bank of America. Those banks offer yields as high as 4.81 percent and as low as 4.25 percent. Use Bankrate’s tools to compare how much you could be earning if you move your account to one of the highest-yielding offers on Bankrate.

“Retail savings rates often move a bit slower in a rising rate environment, but can also fall slower in a declining rate environment,” Marcus’ Ewing says. “Customers who have high-yield savings products could be getting good value in the long run.”

With the likelihood of a Fed pause soon approaching, experts say now may be the time to lock in longer-term CDs. Banks often lower their interest rates as soon as the Fed looks like it won’t be raising interest rates any more.

“If you’ve had your eye on a CD with a maturity of two to five years, now’s the time to grab it,” McBride says.

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

Cheap 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.

On the other hand, markets have been known to choke on the prospect of higher rates. Part of that is by design: Essentially, the U.S. central bank zaps liquidity from the markets when it raises rates, leading to volatility as investors reshuffle their portfolios.

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.

A Fed pause could do little to calm any of those fears if a recession or economic slowdown is feared to be on the horizon.

For those reasons, it’s important to keep a long-term mindset, avoid making any knee-jerk reactions and maintain your regular contributions to your retirement account. When the Fed raises rates, that’s mostly to make sure the financial system doesn’t derail itself by growing too fast. Not to mention, falling stock prices can create tremendous buying opportunities for Americans hoping to bolster their portfolio of long-term investments.

“Low rates are like candy to investors and keeping rates low is like asking the Cookie Monster if there should be more cookies,” McBride says. “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, and 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.”

4. The Fed is one of the main influences of 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 have a prevalent influence on the economy — and for consumers, that also means their purchasing power.

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.

But higher Fed interest rates are the fastest way to weigh on those price increases, though it’s important to point out that consumers won’t immediately feel an impact. The Fed can’t drill for oil or produce more food; all it can do is weigh on demand so much that it balances back out with supply, leading to a lower pace of price increases.

“We’re likely to feel the pain of a slower economy before we see the gain of lower inflation,” McBride says.

Inflation has been cooling. Gasoline prices in March, for example, were 17.4 percent cheaper than they were in March 2022, according to data from the Department of Labor.

Americans, however, are still paying more than they were before the pandemic for the items they both want and need. Groceries have climbed 8.4 percent from a year ago, while rent has jumped 8.8 percent. Services, including the price of dining out at a restaurant, getting a haircut or seeking medical care, are up 7.1 percent. Both categories are contributing the most to inflation.

The Fed’s preferred gauge of inflation (the personal consumption expenditures, or PCE, index) rose 4.2 percent from a year ago through March, a major slowdown from February’s 5.1 percent annual reading, according to the Department of Commerce. Yet, prices are heating up when excluding volatile food and energy costs, rising 4.6 percent over the same 12-month period. PCE tends to track lower than the Department of Labor’s CPI, though both measures are showing inflation remains stubborn.

5. 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. That has implications for more than just businesses. Individuals seeing new opportunities vanish might start to feel insecure about their positions; instead of job hopping to a new company, they might decide to stay put.

All of those moving parts are becoming more apparent now. Job openings are still at a near-record high but have cooled since the Fed started tightening borrowing costs, falling to 9.9 million in February from a record high of 12 million in March 2022, Labor Department data shows.

The unemployment rate is still at a near half-century low, but the question is how much longer that could last. Big tech firms including Meta, Amazon and Lyft have laid off thousands of workers. Apple has begun trimming some of its corporate positions. Layoffs in March rose 319 percent from a year ago, according to data from Challenge, Gray and Christmas. Layoffs, however, are still near record lows, according to the Labor Department.

Revealing just how interconnected the economy is, sometimes a booming labor market can also contribute to inflation. When there’s a mismatch between labor demand and supply, companies often boost wages to recruit more workers. Fed Chair Jerome Powell described it as contributing to today’s stubbornly high inflation in a March congressional testimony, estimating that almost 3.5 million workers are missing since the pandemic-induced recession began in February 2020. Some of that gap may have closed since the Fed started raising rates and slowing the economy, with an April analysis from the Brookings Institution estimating some 900,000 workers are still on the sidelines.

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.

Eight of the Fed’s past nine tightening cycles have ended in a recession, according to an analysis from Roberto Perli, head of global policy at Piper Sandler.

Bottom line

There’s a common mantra when it comes to the Fed: Don’t fight it. Most of the time, it means investors should adjust their decisions to fit monetary policy.

Consumers, however, might want to take the opposite approach. 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.

“You need an emergency fund regardless of where interest rates and inflation are,” McBride says. “You can’t afford to take risks with that money. That’ll stabilize your financial foundation, in the event that tougher economic days lie ahead.”