Why You Might Not Be Able To Get 5% on Cash Soon
Interest rates have been kind to investors over the past couple of years. In January 2022, the fed funds rate was 0.08%. As of April 19, 2024, it was 5.33%. But where will it go in the future? And what does this mean for your cash?
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Here’s what you need to know about interest rates.
What Is the Federal Funds Rate?
The federal funds rate, sometimes called the fed funds rate, is the rate that banks or credit unions charge other banks or credit unions to borrow money overnight. It is set by the Federal Open Market Committee, colloquially known as “the Fed.”
The FOMC meets eight times each year to decide what the federal funds target rate will be. The FOMC changes the rate to encourage the economy to perform better. When inflation is high, for example, the FOMC raises the interest rate. This makes it more expensive to borrow, which reduces spending, which dampens inflation.
How Does the Federal Funds Rate Impact My Savings?
The FOMC does not regulate the amount banks pay you on your savings account or money market account — the free market does that. But because there is so much competition among banks, most banks raise and lower their rates in concert with what the Fed does.
What Will the Fed Do Next?
In addition to announcing any changes in interest rates at the time of each meeting, the FOMC often announces what it expects to do in the future. At the two FOMC so far this year, in January and March, the Fed made no change in the interest rate. This was after raising rates 11 times from March 2022 to July 2023, to try to reduce inflation.
The FOMC announced in December 2023 that it expected to lower the federal funds rate to 4.6% this year — a reduction of 73 basis points, or 0.73%, from the current rate.
Once the Fed makes these cuts, banks are likely to follow suit. This means you won’t be earning 5% on your savings anymore, since the fed funds rate is typically a bit higher than what banks are willing to pay. It’s uncertain exactly when the rate will be lowered, but the Fed is likely to start soon so that it can make a series of smaller cuts over time, to see how the economy reacts.
Savings accounts will still be paying a much better rate at the end of this year than they were in 2022, so there’s no need to do anything drastic. But by the end of 2024, the days of 5% interest on cash may be over.
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