Say goodbye to near-zero interest rates. The Federal Reserve is raising borrowing costs to cool the highest inflation figures in 40 years. The Fed raised its key short-term federal funds rate on Wednesday for the first time since 2018. The quarter-point increase to a range of 0.25-0.50% is the first of what the Fed has expects to be a series of steady increases this year. . “Three…two…one…lift off” is how Lindsey Bell, chief market and money strategist at Ally, a digital bank, described the start of the long-awaited rate-tightening cycle. Fed.
According to the Federal Reserve, those floor rates that have starved your savings accounts but made your borrowing cheaper are set to rise steadily in 2022 and beyond. That means it’s time for pre-retirees and those already retired to start developing a game plan to keep their finances in good shape.
Why Rates Should Rise
At the start of the pandemic in 2020, the economy plunged into a brief and sharp recession. The Fed, whose job it is to fight inflation and keep the economy growing, cut its short-term federal funds rate to near zero and stepped up its bond-buying program to stimulate growth and revive the economy.
The Fed is now turning to less stimulative policy to cool the economy and combat soaring inflation caused by pent-up demand, supply chain disruptions and, more recently, the spike in oil prices caused by Russia’s invasion of Ukraine. In February, consumer prices rose 7.9% from a year ago, its fastest pace since 1982. At the same time, the country’s unemployment rate fell to 3.8% , bringing the labor market closer to the Fed’s maximum employment target.
The Fed now expects it to raise its key rate six more times this year, in quarter-point increments. “It’s clearly time to raise interest rates,” Fed Chairman Jerome Powell told a press conference, adding that the economy is very strong and well positioned to bear the costs of higher loan.
A victory for savers in need of income
While the Fed’s stimulus succeeded in bringing the economy back from the brink after the COVID-19 shutdown in 2020, it punished savers, especially retirees who rely on secure and stable income. Money stashed in a savings or money market account, for example, currently earns only 0.06 and 0.08 percent interest, respectively, and a 12-month certificate of deposit, or CD, only earns than 0.14%, according to the latest data from the Federal Deposit Insurance Corporation (FDIC).
“Let’s face it. The low yields have been great for people looking to borrow, but the low interest rates have been pretty painful for savers,” says Warren Pierson, the firm’s managing director and co-chief investment officer. Baird Advisors fund management.
Some of the pain for savers will ease as the Fed raises rates. “Retirees tend to take advantage of rising rates,” says Gary Schlossberg, global strategist for Wells Fargo Investment Institute.
Yet savers should not expect a lottery-like windfall overnight. While rates are expected to rise in 2022, 2023 and 2024 to around 3%, they are starting from such a low base that the gains savers see on cash placed in money market accounts and CDs will be modest. A $10,000 12-month CD, for example, which a year from now might earn nearly 2% interest, would still only earn $200 in interest each year. And if inflation stays high, the returns on your savings still won’t keep up with the rising prices of the things you buy like food, gas and furniture, say personal finance professionals. “Rates are low and modest increases aren’t going to change that,” said Greg McBride, chief financial analyst at Bankrate.com.
Don’t expect the nation’s biggest banks to quickly increase the interest they pay in cash every time the nation’s central bank raises rates by a quarter of a percentage point, McBride adds. Banks are already sitting on a mountain of deposits and don’t need to raise rates to provide more liquidity, he says. If you intend to get the highest return on your cash savings, your best bet is to go with an online bank, which offers much more competitive rates, McBride says.