Here's What Happens to Your Savings When the Fed Lowers Interest Rates

The Fed isn't planning to cut rates just yet, but here's what to expect when they do.

The Federal Reserve has been raising interest rates aggressively in an effort to cool off the economy and get inflation under control. As a result, many savings accounts are paying significantly higher interest rates than they were just a year ago. Most of the best high-yield savings accounts currently have APRs in the 3.3% to 4% range, which would have been unheard of not long ago.

To be sure, the Federal Open Market Committee (FOMC -- the policy-making arm of the Fed) isn't planning on cutting rates anytime soon. But when they do, what will it mean for your savings account interest? Here's what you need to know as we approach the expected latter stages of the current rate hike cycle.

What does it mean when the Fed raises or lowers rates?

When you hear the Federal Reserve "raised rates," it typically refers to the federal funds rate. In simple terms, this is the interest rate banks charge other banks to borrow money. When the federal funds rate is raised, it makes it more expensive to borrow and effectively removes money from the economy. When the federal funds rate is lower, it encourages banks to borrow and increases the money in the economy. The idea is that a lower federal funds rate stimulates economic activity, and a higher federal funds rate is a tool used to help the economy cool off.

For our purposes, the federal funds rate is used as a benchmark interest rate. Several important interest rates are directly derived from the federal funds rate, with the U.S. prime rate the key example. Some consumer interest rates, such as credit card APRs, move directly with the federal funds rate. Others, like savings account interest rates, are not directly tied to it, but are still impacted.

When will the Fed cut rates?

The short answer is that nobody knows, but it's very important to realize that the Fed doesn't want to keep rates high for any longer than it needs to.

For some clues, the latest projections by the actual policy makers call for the federal funds rate to rise to about 5.1% by the end of 2023, so we're looking at another three rate hikes from the current 4.25% to 4.5% target range (Note: Federal Reserve rate hikes are done in 25-basis-point increments.)

However, the median projection also has rates falling to 4.1% by the end of 2024 and to 3.1% by the end of 2025. These projections can (and probably will) change, but the key takeaway is that the Fed plans to start lowering rates in the not-too-distant future.

What does a rate cut mean for your savings account?

Here's an important concept for savings account owners to understand. Your savings account yield, or APY, is not directly tied to the Federal Reserve's moves. If that were the case, savings account interest rates would be about 4.25% higher than they were this time a year ago, which isn't the case. In reality, the typical high-yield savings account pays two to three percentage points more than before the Fed started raising rates.

However, savings interest rates do tend to move in the same direction as benchmark rates. So, if the Fed starts to lower the federal funds rate, either later this year or sometime next year, it would likely mean the APY paid by your savings account would decline. It's just a question of how quickly and by how much, and those two variables mainly depend on your bank, not the Federal Reserve.