The Various Effects of the Federal Reserve on Your Finances: 6 Key Ways –

Have you leveraged the strong job market to ask for higher pay or find a new position? Have you been holding off on buying a home until you find a cheaper deal and a 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 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 invest in new initiatives. Expensive rates, however, can cause both businesses and consumers to pull back on big-ticket purchases — as well as hiring.

After raising interest rates a whopping 5 percentage points since March 2022, the Fed looks like it’s closer to the end of its rapid rate hikes than the beginning. The impact, however, will live on: The best savings yields are now topping inflation, but borrowing costs have hit their highest in more than a decade. The rate environment is unlikely to shift materially until the Fed begins cutting interest rates — a step that looks increasingly unlikely this year, with price pressures still stubborn.

Here are the six 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. 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.

Case in point, here’s how much more expensive it’s gotten to finance various big-ticket items this year, after 5 percentage points worth of tightening from the Fed:

Product	Week ending July 21, 2021	Week ending July 19, 2023	Percentage point change
30-year fixed-rate mortgage	3.04 percent	6.88 percent	+3.84 percentage points
$30k home equity line of credit (HELOC)	4.24 percent	8.58 percent	+4.34 percentage points
Home equity loans	5.33 percent	8.47 percent	+3.14 percentage points
Credit card	16.16 percent	20.44 percent	+4.28 percentage points
Four-year used car loan	4.8 percent	7.79 percent	+2.99 percentage points
Five-year new car loan	4.18 percent	7.24 percent	+3.06 percentage points

Source: Bankrate national survey data

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

One place where higher rates have been clear: credit cards. The average interest rate on a credit card has ratcheted to new record highs throughout 2023. After hitting the latest series high of 20.58 percent by July 12, credit card annual percentage rates (APRs) bounced back down to 20.44 percent the next week. Those higher interest rates, however, won’t impact you if you pay off your credit card balance in full each month.

“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.

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.

An inflation surprise helped send the 10-year Treasury yield surging past 4 percent last October, the highest since 2008. That sent the 30-year fixed-rate mortgage to a 20-year high of 7.12 percent, Bankrate’s rate data shows.

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 Silicon Valley Bank and First Republic collapsed weighed on the key yield even more. By early April, 10-year Treasury yield fell almost a full percentage point from its peak.

Mortgage rates started regaining ground in the summer of 2023, when the price of financing a home with a 30-year fixed mortgage surged back up again to 7.07 percent by July 12. They’ve since leveled off, but only slightly, hitting 6.88 percent by July 19.

That all might be because investors are starting to accept that the Fed won’t be cutting rates as soon as they thought, McBride says.

“At some point, someone was going to be proven wrong,” he says.

2. Higher rates from the Fed don’t just make it more expensive to take out a loan — but also harder to get approved

One of the reasons why higher interest rates slow demand: They cut off households from the never-ending credit spigot. Consequently, less access to credit leads to less spending — weighing on demand and taking some of the steam away from inflation.

A New York Fed report released July 17 showed application rates for new credit declined the most since October 2020, suggesting households have less interest in taking out a loan amid the rapid run-up in borrowing costs.

But rejection rates for any kind of credit — including mortgages, credit cards and auto loans — also grew, hitting the highest in five years. A record share of auto loans weren’t approved, the report showed, while the likelihood of being rejected for a mortgage also rose to a new series high, the report showed. Rejection rates were highest for individuals with credit scores below 680.

The phenomenon reflects one of the key features of a rising-rate environment: Lenders grow pickier about who they lend money to, out of fear that they may not be paid back.

It all means that rates may climb even faster for borrowers perceived to be riskier, and some lenders might focus instead of lending out only to borrowers with better credit scores.

Financial firms may fear that the risk of default is higher because monthly payments effectively become costlier when interest rates are high. Take the 30-year fixed-rate mortgage, for example. A $500,000 mortgage would’ve cost you $2,089 a month in principal and interest when rates were at a record low of 2.93 percent, according to Bankrate’s national survey data. When the average 30-year fixed-rate mortgage hit 7.07%, that same payment would’ve cost $3,350 a month.

“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.”

3. 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 aren’t clamoring for the deposits, especially today.

The average savings yield is almost five times higher than it was at this time last year, rising from 0.11 percent to 0.52 percent as of July 19, the highest since March 2007, according to national Bankrate data.

Meanwhile, a 5-year certificate of deposit (CD) was paying an average 0.65 percent yield one year ago. Today, it’s offering an average yield of 1.29 percent.

But there are banks offering even more money in interest, and finding them could help consumers preserve some of their purchasing power in the face of still-elevated 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 July 21, the 10 banks ranked for July 2023 are offering an average yield of 4.8 percent, nearly 9 times the national average and 400-500 times higher than yields at Chase and Bank of America. Those banks offer yields as high as 5.05 percent and as low as 4.5 percent, all of which are beating overall inflation. 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.

4. 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.

Investors, however, look like they have some hope. The S&P 500 is up almost 19 percent since the start of the year and is only now down about 5 percent from its peak. The growing optimism is likely tied to the U.S. economy’s surprising resilience in the face of higher rates. Headline inflation has cooled to 3 percent from its 9.1 percent high of June 2022, all while unemployment is still near a half-century low and job growth is booming at a pace faster than before the pandemic. Economists in Bankrate’s survey put the odds of a downturn at 59 percent, the lowest in a year.

But that doesn’t mean the economy is in the clear. Recession odds that are still above 50 percent show that a downturn is more probable than not. An unforeseen foe, meanwhile, could always show up and harm economic growth. Take earlier this year, for example. Markets were similarly optimistic about the economy’s chances of avoiding a recession. Then, Silicon Valley Bank failed, kicking off turmoil for regional banks and sparking the closures of two more major banks.

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.”

5. 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.

Higher Fed interest rates are the main 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. That process, however, can take time, with some research suggesting it takes a full year, if not longer, for one rate hike to make its way through the entire economy.

“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 May, for example, are 26.5 percent cheaper than they were in June 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 4.7 percent from a year ago, while rent has jumped 8.3 percent. Services, including the price of dining out at a restaurant, getting a haircut or seeking medical care, are up 5.7 percent. The latter two categories are contributing the most to inflation.

The Fed’s preferred gauge of inflation (the personal consumption expenditures, or PCE, index) rose 3.8 percent from a year ago through May after a 4.3 percent increase in the prior month. Price increases also picked up when excluding volatile food and energy costs, rising 4.6 percent over the same 12-month period. That compares with the Department of Labor’s consumer price index (CPI) gauge, which showed overall inflation up 3 percent from a year ago, while rising 4.8 percent over the same time period when excluding food and energy prices.

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.

That has implications for more than just businesses. Workers 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 (though recession fears don’t appear to be stopping them yet).

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 9.8 million in May from a record high of 12 million in March 2022, Labor Department data shows. Job creation in June, meanwhile, dropped to the slowest pace since the pandemic, though employers are still creating jobs faster than they were in 2019.

The unemployment rate is still at a near half-century low, but some industries have been tougher 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 show job cuts are up 25 percent from this time last year but fell 49 percent from the previous month, suggesting they may be moderating.

Layoffs aren’t widespread in data from the Labor Department, and they’re continuing to hold near record lows. The question, however, is how long that could last. Even though the job market is still chugging along, economists in Bankrate’s quarterly poll see joblessness rising from its current 3.6 percent level to 4.5 percent, while job growth is projected to be almost 11 time slower over the next 12 months than it was in the previous year,

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. More Americans between the ages of 25-54 – the so-called “prime” worker — are now working than before the coronavirus pandemic, but workers who are 55 and older are missing, Labor Department data shows.

How much tight labor markets are currently contributing to inflation is also up for debate. Research from the San Francisco Fed suggests higher wages are currently only contributing 0.1 percentage point to the growth to the Department of Commerce’s measure of inflation, excluding food and energy. Companies have been able to eat the higher cost of labor or make savings down the line with increased automation or efficiency, economist Adam Shapiro suggested in the research.

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.”