The Fed increased interest rates again — here's why you should save more and pay off debt in response (2024)

FAQs

What are the benefits of the Federal Reserve raising interest rates? ›

On the positive side, higher interest rates can benefit savers as banks increase yields to attract more deposits. The average savings yield is now almost 10 times higher than it was when the Fed first started raising rates, and online banks often offer even higher yields.

After the pandemic, inflation skyrocketed as prices on everything from rent to food increased. In response, the Federal Reserve started increasing interest rates to cool the pace of rising prices, hiking its benchmark rate 11 times over a year and half.

As interest rates rise, the interest income from loans typically increases faster than the interest paid on deposits, leading to wider profit margins. Additionally, higher interest rates can boost the earnings of insurance companies and investment firms, as they often hold large portfolios of interest-sensitive assets.

The Fed raises interest rates to slow the amount of money circulating through the economy and drive down aggregate demand. With higher interest rates, there will be lower demand for goods and services, and the prices for those goods and services should fall.

The Bottom Line

Generally, when interest rates are high, people will spend less and save more, as the cost of borrowing money to buy items such as houses and cars increases, whereas the return on savings deposits is higher.

The Fed pays interest on reserves to banks and to other financial institutions that have, effectively, made deposits at the Fed. As long as the Treasury interest the Fed receives is greater than the interest the Fed pays, the Fed makes money. It spends some, and returns the balance to the Treasury.

Higher interest rates typically slow down the economy since it costs more for consumers and businesses to borrow money. But while higher interest rates can make it more expensive to borrow and could hamper overall economic growth, there are also some benefits.

Because higher interest rates mean higher borrowing costs, people will eventually start spending less. The demand for goods and services will then drop, which will cause inflation to fall. Similarly, to combat the rising inflation in 2022, the Fed has been increasing rates throughout the year.

Projections suggest that we may see no rate increases in 2024, and that the Fed might start dropping its rate later this year, according to the CME FedWatch Tool on April 30. If the Fed rate drops, CD rates will likely follow suit, though it's up to each bank and credit union if and when that occurs.

With profit margins that actually expand as rates climb, entities like banks, insurance companies, brokerage firms, and money managers generally benefit from higher interest rates.

Who makes more money when interest rates rise? ›

Unsurprisingly, bond buyers, lenders, and savers all benefit from higher rates in the early days. Bond yields, in particular, typically move higher even before the Fed raises rates, and bond investors can earn more without taking on additional default risk since the economy is still going strong.

When interest rates are higher, banks make more money by taking advantage of the greater spread between the interest they pay to their customers and the profits they earn by investing. A bank can earn a full percentage point more than it pays in interest simply by lending out the money at short-term interest rates.

A Fed rate hike can lead to higher rates for regular savings accounts and CDs, but the differences between these accounts can impact which to use and when. A regular savings account usually has a variable rate, meaning it can change.

As a general rule of thumb, when the Federal Reserve cuts interest rates, it causes the stock market to go up; when the Federal Reserve raises interest rates, it causes the stock market to go down. But there is no guarantee as to how the market will react to any given interest rate change.

If interest rates rise, that means individuals will see a higher return on their savings. This removes the need for individuals to take on added risk by investing in stocks, resulting in less demand for stocks.

The Pros of Rising Interest Rates

There are some upsides to rising rates: More interest for savers. Banks typically increase the amount of interest they pay on deposits over time when the Federal Reserve raises interest rates. Fixed income securities tend to offer higher rates of interest as well.

Pros of the Federal Reserve

The Federal Reserve helps stabilize the U.S. economy, including consumer prices and the labor market. The Federal Reserve also works to limit the severity and duration of economic downturns. Banking oversight.

The payment of interest on excess balances will permit the Desk to keep the federal funds rate closer to the target even as the Federal Reserve provides the necessary liquidity to support financial stability through its liquidity facilities.