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How The Federal Funds Rate Affects Banks And Your Savings


December 2, 2019

The banking world revolves around the U.S. Federal Reserve. And banks’ interest rates revolve around the Fed’s federal funds rate, for both loans and savings. While there is no law or equation governing how checking, savings, high yield savings accounts or certificates of deposit must align with the federal funds rate, changes to the federal funds rate cause banks and investors to adjust accordingly.


What is the Federal Funds Rate?

The federal funds rate is the interest rate at which banks lend to each other for short-term loans they may need to meet reserve requirements.


Adjusting the federal funds rate is the Fed’s primary tool for doing its official two-prong job: keeping consumer price inflation around a 2 percent target and the economy at full employment. Here’s how it works:

  • Increasing the federal funds rate tends to reduce inflation and cool the economy;
  • Reducing the federal funds rate tends to increase inflation and stimulate the economy.

So, if it looks as if inflation is rising above that key 2 percent level, the Fed is likely to increase the federal funds rate. But if it looks as if inflation is falling below the 2 percent level, the Fed may reduce the rate.


Periodically, the Federal Open Market Committee (FOMC) announces a new target range for the federal funds rate, based on its forecasts for the American economy. From 2015 to 2018, the Fed raised the federal funds rate several times. In 2019 it reversed course and has lowered the rate twice, with many economists predicting more rate cuts to come.


How Federal Funds Rate Changes Affect Bank Lending

Banks typically borrow funds at or near the federal funds rate and lend to customers at higher rates. The U.S. “prime” lending rate, to which many variable-rate consumer loans and mortgages are linked, is the federal funds rate plus about 3 percent.1 Thus, the interest rate on variable-rate loans will generally—and automatically—rise when the Fed raises the federal funds rate and fall when the rate is cut.


Other consumer loans, and most mortgages, are at fixed interest rates. Those rates don’t vary as the federal funds rate changes, but the interest rate on new loans and mortgages depends on the federal funds rate in force at the time the loan is made.


Why Changes in the Federal Funds Rate Affect Your Savings

Banks don’t just borrow funds from each other. In fact, most of their funding comes from you—regular people’s money deposited in checking and savings accounts and certificates of deposit.


Banks pay interest on savings accounts and CDs. However, since they can always borrow funds from each other at the federal funds rate, they don’t like to pay much above that rate for other funding sources, like customer deposits. So, when the Fed cuts the federal funds rate, banks are likely to respond by reducing interest rates on savings accounts and CDs. Sometimes, banks even cut interest rates in anticipation of a Fed rate cut.


Many CDs have fixed interest rates. When the Fed cuts the federal funds rate, existing holders of these CDs won’t be affected. However, new CDs will be likely to have lower rates of interest. Conversely, when the Fed raises the federal funds rate, existing holders of fixed-rate CDs can lose out because their interest rates don’t adjust. You can withdraw money from a CD early, but this is likely to be at a penalty cost, for example twelve months’ interest. Variable-rate CDs offer you the opportunity to benefit from rising rates, but of course if rates fall then the interest on a variable-rate CD is likely to fall too.


As a saver, it is important to remember that while variable rates fluctuate over time, one constant is that your money is safe when you deposit in an FDIC-insured bank, which provides standard insurance on your investment up to $250,000 per depositor, per account type.

The Bottom Line


Changes in the federal funds rate affect the interest rates that banks will pay on savings accounts and CDs. The amount by which interest rates move with the federal funds rate varies from bank to bank. Savers should expect interest rate increases when the federal funds rate is going up and lower interest rates when the federal funds rate is falling (possibly even in anticipation of future reductions).

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†Accounts offered by American

Express National Bank. Member FDIC. Each depositor is insured to at least $250,000 per depositor, per insured bank, per ownership category.

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*The Annual Percentage Yield (APY) as advertised is accurate as of . Interest rate and APY are subject to change at any time without notice before and after a High Yield Savings Account is opened.


For a CD account, rates are subject to change at any time without notice before the account is funded. The rate received will either be (i) the rate reflected during your application process or (ii) the rate being offered when your CD is funded, whichever is higher. All CDs must be funded within 60 calendar days from the time we approve your application or will be subject to closure. The interest rate and Annual Percentage Yield (APY) will be disclosed in your account-opening documents, which you will receive after completing your account-opening deposit. After a CD is opened, additional deposits to the account are not permitted. Early CD withdrawals may be subject to significant penalties which could cause you to lose some of your principal. Please see the Deposit Account Agreement for additional terms and conditions and Truth-in-Savings disclosures.


**The national rate referenced is from the FDIC's published Monthly Rate Cap Information for Savings deposit products. Visit the FDIC website for details.


‡For purposes of transferring funds, business days are Monday through Friday, excluding holidays. Transfers can be initiated 24/7 via the website or phone, but any transfers initiated after 7:00 PM Eastern Time or on non-business days will begin processing on the next business day. Funds deposited into your account may be subject to holds. See the Funds Availability section of your Deposit Account Agreement for more information.


♢Calculations are estimates of expected interest earned. Actual results may vary, based on various factors such as leap years, timing of deposits, rounding, and variation in interest rates. The first recurring deposit is assumed to begin in the second period after any initial deposit.


§IRA Contributions are subject to aggregate annual limits across all IRA plans held at American Express or other institutions. IRA distributions may be taxed and subject to penalties based on IRS guidelines. Required minimum distribution, if applicable, is only relevant to this IRA plan and does not take into consideration other IRA plans held at American Express or other institutions. Please see for more information. We recommend you consult with a financial or tax advisor when making contributions to and distributions from an IRA plan account.