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Your strategy when the federal funds rate rises

The Federal Reserve released a statement on June 13, 2018, announcing a 0.25 percent increase in its target interest rate range, boosting that range to between 1.75 percent and 2.00 percent. This is the latest in a series of incremental rate increases the Fed has made beginning December 2015.

Consumers with deposit accounts who have been looking forward to seeing bank rates rise may find the results of the Fed's rate increases very disappointing. So far, rate movements since those increases began have cost consumers more than they have helped them.

Federal funds rate signals momentum

The Fed's mission is to try to balance two goals: stabilize inflation and encourage economic growth. These goals can be somewhat in conflict because raising rates can help control inflation -- but it can stifle economic growth. Conversely, lowering rates may encourage economic growth -- but it also tends to fuel inflation.

Monetary policy decisions are clearest when inflation and growth are somewhat in sync -- that is, if both are rising, an increase in interest rates may be indicated, while a decrease in rates may be appropriate if both are weakening.

The context for the Fed's latest decision to raise rates was challenging because inflation and growth look like they may be slipping out of sync. Inflation has been strengthening lately, while economic growth is slowing. The move to raise rates in this environment suggests that the Fed is keen to stay out ahead of inflation and has faith that the economy will regain its momentum.

With inflation rising but growth slowing, in effect the tie-breaker in the Fed's decision to raise rates may have been the long-term goal of policy normalization. Having pushed rates to extraordinarily low levels, the Fed needs to restore them closer to normal levels or else its policy options will be more limited in the next recession. The risk is that raising rates too quickly could hasten the appearance of that next recession.

Fed policy influences consumers

The Fed's effort to stabilize inflation and spur economic growth affects consumers too. In reaction to the financial crisis and Great Recession a decade ago, the Fed pushed interest rates to extremely low levels in an attempt to stimulate the economy by encouraging borrowing. It certainly did encourage borrowing: credit card debt, student loan debt, car loan debt, and mortgage debt outstanding are now all at record levels.

Back then, banks were eager to drop interest rates to compete for credit cards and loans. Now that the federal funds rate is on the rise, one would hope that banks would be as eager to reward depositors with higher interest rates on CDs, savings and money market accounts too. So far, though, this benefit has been muted:

Since December of 2015, savings account rates have risen by a mere 0.02 percent, money market rates by just 0.12 percent, and 1-year CD rates by only 0.38 percent.

Even though consumers may be getting the short end of the stick here, they aren't entirely powerless in the situation -- if they are willing to rethink their strategy as interest rates rise.

Your strategy when fed funds rate rises

In this economic environment, consumers should take a two-pronged approach to protect their assets:

  • Drop debt
    If low interest rates were designed to encourage borrowing, consumers would be wise to view rising rates as their cue to reduce borrowing. If not, rising rates will hit consumers especially hard since they will be paying higher interest on record amounts of debt.

  • Shop for better bank rates
    Unfortunately, banks increase interest rates on deposits much more slowly. However, MoneyRates.com has identified several banks which not only offer rates that are significantly higher than industry averages already, but that are rising more quickly. These banks are the exception rather than the rule, but they are easy to find using the MoneyRates.com shopping tools for savings accounts, CDs, and money market accounts.

The Fed seems likely to continue its upward direction for interest rates for a while. The message for consumers is clear: reduce debt and shop actively for better bank rates, or else the trend toward higher interest rates will hurt you more than it will help you.

Previous Federal Reserve Board Update Articles:

Interest rates surge despite Fed's inaction

Fed rate increases not helping consumers

3 ways to profit when market rates outpace the Fed

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