Bank of Dudley

The Federal Reserve has started lowering the Federal Fund Rate, commonly called the Federal Reserve Interest Rate, in response to recent declines in inflation. Depending on your financial situation, that may be incredibly good news or disappointing news. With more cuts expected before the end of 2025, all bank customers need to understand how a Fed rate change can affect them.

It’s a topic that’s been all over the news for the last several months: when will the Federal Reserve (“the Fed”) next change interest rates in the United States? As our nation’s economy has fought to recover from the setbacks suffered during 2020, few questions have been asked more frequently in the world of finance.

The Fed began lowering rates in September 2024, but what does that mean? Well, that answer depends on how the Fed adjusts rates and what kinds of loans and interest-bearing accounts you have.

This month, we’ll take a look at how the Federal Reserve sets interest rates and how that impacts banking and investments.

What Is the Federal Reserve?

The Federal Reserve System is the central banking system of the United States, and it wears many different hats. It’s responsible for regulating banks and serving as the primary bank for the United States government. More importantly for this article, the Fed also serves as a “bank for banks” and uses that role to help stabilize and manage the US economy.

What Is the Federal Reserve Interest Rate?

Technically, the rate that most people refer to as the Federal Reserve Interest Rate is called the “Federal Funds Rate,” and it’s actually a range of rates, not a single rate. (For instance, the current rate range is 4.75 – 5%).  There’s a second rate, called the “discount rate” which is also set by the Fed, usually higher than the fund rate. Understanding how these interest rates affect the economy means taking a quick look at how the Fed earns interest from or pays interest to their member banks.

Banks that have joined the Federal Reserve system are referred to as “member banks.” While all national banks are required to be member banks, state-chartered banks may choose whether or not to join the Fed.

Every Federal Reserve member bank in the US is required to open a deposit account at one of the 12 district Federal Reserve Banks across the US (Bank of Dudley’s account is at the Federal Reserve Bank in Atlanta). This account is an interest-earning account called a “reserve account” or just a “reserve.”

At the end of every business day, the Fed pays interest into those reserve accounts, or “Interest on Reserve Balance” (IORB). The rate at which these reserve accounts draw interest will always fall within the range set as the federal fund rate.

If a member bank has a liquidity need – a need for increased cash reserves – they are allowed to borrow from the Federal Reserve at the discount rate. Since the discount rate will always be higher than the federal funds rate, banks typically try to avoid borrowing from the Fed unless they have a genuine liquidity need.

How Does the Federal Reserve Interest Rate Impact the Whole Economy?

When the Fed lowers fund rate and the discount rate, both lending rates and yield rates at individual banks tend to go down. When the Fed rates increase, bank rates tend to track with them.

Just that one little fluctuation—the interest rates that the Fed charges and pays to member banks—impacts the entire economy. When consumer spending is down and the economy is sluggish, lowering the Federal Fund Rate tends to lower lending costs, encouraging people to borrow money from banks and pump it into the economy, buying cars, houses, and millions of other things. When inflation is high, increasing interest rates increases the cost of borrowing, reduces the demand for high-value purchases, and helps hold consumer prices down.

What Does a Federal Reserve Interest Rate Change Mean for Me?

That depends on a lot of variables, and depending on your situation, it may mean an increase in fortunes or a moderate decline. The easiest way to look at it is to explain how the rate change affects certain banking products and services.

Loans

Loan rates tend to track with federal fund rates, so a decrease means that construction loans, business loans, and personal loans will originate at a lower interest rate, reducing the cost of borrowing money. An increase means the opposite.

Interest-Bearing Accounts

The rate paid by banks to customers who have money in interest-bearing accounts such as money markets, CDs, IRAs, and some checking and savings accounts also tracks with the Fed rate. In this case, though, consumers prefer to see the rates go up – when rates go up, the money they’ve saved earns more interest.

With more rate decreases expected from the Federal Reserve, account yield rates will also start to drop. If you’re planning to invest in products like CDs or IRAs that offer a fixed interest rate, you should carefully monitor rates and projections and make your investment so you can invest at the best possible time.

What Will the Federal Reserve Interest Rate Do in the Near Future?

In September 2024, the Fed made its first cut of the Federal Fund Rate in almost four years, easing rates now that the dramatic inflation of the last four years has started to level out some. The cut, a reduction of one-half of a percentage point, was viewed as aggressive—the Fed seldom moves the fund rate more than a quarter of a point at a time.

At each of the Fed’s eight annual meetings, the central bank’s leadership discusses any possible rate changes, votes on them, and then issues their “Summary of Economic Projections,” a short document providing expert forecasting on the economy’s state. Each summary contains a page commonly called the “dot plot,” a graph showing where each Fed official thinks the Fed rate should be at the end of this year and the next. To get an idea of where Fed rates may be heading in the next 18 months, download the latest summary and look at page 4 to see the current “dot plot.”

Need to Know More About What the Federal Reserve Interest Rate Changes Will Mean for You? We Can Help!

Since 1905, the team at Bank of Dudley has remained dedicated to helping our neighbors find financial success. Our local bankers are always ready to help you navigate the complex world of personal and business banking, and we’re 100% committed to helping you find the products and services that work for you – and helping you understand what shifts in the economy mean for you.

Call today and discover true relationship banking: 478-277-1500