How the Federal Reserve impacts savings accounts

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The Federal Reserve on Sunday slashed rates to a range of 0-0.25 percent in a second emergency decision. For savers, it could mean earning lower payouts.

Banks offering top rates tend to pay savers less when the central bank makes a cut and more when the central bank makes a hike. While it remains to be seen how banks respond to the Federal Reserve’s latest cut, savers’ wallets were hurt by the Fed cutting interest rates three times in 2019. Banks competing on rates, like Ally Bank and Marcus by Goldman Sachs, lowered their payouts to savers around the times when the central bank made cuts.

With the Fed’s latest interest rate cut, yields on savings accounts could drop again. The good news for savers is that competition for your cash among online banks is fierce and you’ll still have compelling options.

“While the Fed is a big factor in the trend on savings rates, how an individual bank responds ultimately boils down to their need for deposits,” says Greg McBride, CFA, Bankrate chief financial analyst. “As consumers, we can exploit this to our advantage by shopping around for the most competitive yields being offered.”

For anyone hoping to make saving money a top priority, here’s what to consider when the Fed makes a change to the fed funds rate.

The loose link between the Fed and your high-yield savings account

Congress mandates the Fed to maintain economic and financial stability. Primarily, the central bank does so by raising or lowering the cost of borrowing money. Savings account rates are loosely linked to the rates the Fed sets. After the central bank lowers its rate, financial institutions tend to pay less interest on high-yield savings accounts to protect their profits.

While the Fed has raised rates nine times since 2015, the central bank cut interest rates by a quarter of a percentage point in July, again in September and once more in October. Some of the best rates have dropped. And in March, the Fed has made two emergency cuts, bringing rates to a range of 0-0.25 percent.

The impact on your wallet doesn’t always hit right away. Nor is it inevitable. Online banks tend to compete on price, while brick-and-mortar banks tend to avoid paying savers competitive yields. The savings accounts vary dramatically. Large banks tend to pay 0.1 percent APY or worse, but you can still find top savings accounts paying around 1.8 percent APY.

Part of the reason the highest yields have held up is due to escalating competition. Online banks are in hot pursuit to attract and keep deposits as new threats continue to mount. Offering a high-yield account is among the tried-and-true strategies to court customers with a compelling offer — especially for relatively new and small digital banks.

Deposits, in general, are essential to banks’ business models: They are used as a low-cost funding source to fuel loan demand.

“Bankers don’t get deposits just because it’s cool to have deposits,” says Neil Stanley, CEO and founder at The CorePoint, a bank management solutions company. “They get them because they can invest them in loans.”

If banks make money on investing deposits in loans, then they can afford to pay more for deposits. Spoiler alert: banks are (usually) profitable.

To be sure, not every bank is hungry for more deposits right now. Whether and when banks respond to the Fed changing the rate will vary based on what objectives they are trying to accomplish.

“Every bank could be a little different on this in terms of what their pressures are,” says Betty Cowell,  a senior adviser at Simon-Kucher & Partners.

What savers should do

While the average yield on a traditional savings account is paltry (0.1 percent), you can still find a number  of savings accounts paying 1.8 percent APY or more. While these accounts won’t make you rich, they will help you earn something.

 “As long as you’re shopping around for the best yields and continue to monitor how your interest earnings stack up against the best available, don’t worry so much about what the Fed is doing with interest rates,” McBride says. “Instead, measure your returns relative to the rate of inflation — that is the real scorecard for savers.”

Right now, you will want to earn more than 1.6 percent APY to avoid losing purchasing power.

While online banks are known for paying the highest yields, shop around. Also, consider cash management accounts and money market accounts to find the best deals.

Don’t automatically accept the offer advertised, however. At a time when competition is intense, you have room to negotiate — plenty of banks don’t want to miss out on your business.

“The bank feels very vulnerable to that depositor,”  Stanley says. “The depositors have more power than they probably think they have.”

As you seek out enticing offers, make sure to read the fine print about fees and minimum balances before signing up. Pay attention to whether the account offers the features you need. Don’t settle for the first search result either.

“If you are a shopper in the market today, hop online and compare prices and go with the brand you trust,” Cowell says.