Rate cuts, the Fed, and your money

The Federal Reserve, the central bank of the United States, sets a target interest rate—aka the federal funds rate—8 times a year. Generally, the decision to change rates is based on whether the goal is to boost the economy or restrain inflation. For example, to stimulate economic growth, Fed officials might decide to lower the fed funds rate. If so, the impact can be both positive and negative for investors because falling interest rates typically mean lower costs to borrow on loans but also lower annual percentage yields (APYs) offered on many interest-bearing accounts, such as Robinhood Gold.

Historically, the fed funds rate has been as low as 0% (like during pandemic in 2020) and as high as nearly 20% (in the high inflation times of the early 1980s). The Federal Reserve aggressively lowered rates towards 0% and took other action in response to the pandemic in March 2020, but then began a series of rate increases to curtail inflation starting in 2022.

After hiking rates 11 times in its fight against inflation, the Fed announced a final increase in July 2023, which pushed the fed funds rate to more than 5% (target range of 5.25% to 5.5%) and the highest level in more than 20 years. Then in September 2024, as inflation pressures abated, the Federal Reserve cut the fed funds rate by 50 basis points (.50%) to a target range of 4.75% to 5%.

For everyday investors, the impact of interest rate changes can be both positive and negative because of the effect on 1) interest earned on savings and 2) the cost to take out personal loans or to hold credit card balances.

• When the Fed cuts rates, it directly impacts the potential rate earned on any high yield savings accounts, new certificates of deposits (CDs), and money market funds. While these types of short-term investments can remain an option for placing uninvested cash because they’ll still generate interest, APYs are likely to decline after the fed funds rate decreases. Note that Robinhood doesn’t currently offer savings accounts or CDs.

• That being said, from another lens, it can be good news for consumers when rates go down. For example, as the federal funds rate goes down, so can interest rates for certain credit cards, car loans, mortgages, and other loans—though by how much and how soon they change varies widely. That means when the Fed cuts their rate, not only might you get lower rates for new debt, but rates on existing debt (like adjustable-rate mortgages or your credit card) may decrease as well.
• On the other hand, if the Fed increases the target federal funds rate, borrowing becomes more expensive. As a result, rates on certain new loans may rise, but then APYs may rise.

In times of rapid inflation, like we had in 2022, the Fed might decide to use contractionary monetary policy and increase interest rates. In that case, the price of borrowing goes up, and banks charge higher interest rates on loans — including on loans to each other. Higher rates are typically intended to increase savings versus spending, cool the economy (as well as demand) and thus, stabilize prices.

On the other hand, suppose the U.S. is experiencing a recession, and the Fed wants to help boost the economy. They would likely cut interest rates, allowing more money for commercial banks to lend to customers. Banks, in turn, lower their interest rates to entice customers to borrow the money. When interest rates are lower, people tend to take out more loans and spend more money. When people spend more money, save less as they earn less on deposits, and the economy tends to grow.

Finally, federal funds rate increases and decreases can also sway the stock market. Because, at its core, investing often represents participation in potential future cash flows and income. Valuing many investments means you have to translate the potential future back to today's value using interest rates. All else equal, the higher interest rates are in general, the lower the resulting calculated value is of any investment. In other words, falling interest rates are typically viewed as a positive for long-term valuations in the stock market.

The Federal Reserve has a dual mandate to keep the economy humming while maintaining a lid on inflation. The federal funds rate is a key tool in achieving its objectives. During periods of high inflation, the Fed will try to stabilize prices by raising the fed funds rate. Other times, officials will attempt to boost the economy by lowering rates. Changes in rates, higher or lower, can be both positives and negatives for investors because of the effect on both borrowing rates and investment yields.