The Federal Funds Rate And How It Impacts You

At 2 p.m. EST, the Federal Reserve is expected to announce another interest rate hike. While most Americans are familiar with the idea of a federal interest rate, interest rates on different U.S. bonds, bank accounts, credit cards, mortgages and other financial instruments vary widely.

Update: The Fed announced it will up the fed funds target rate by 0.25 percent to a range of 0.75-1.0 percent.

What rate exactly is the Federal Reserve changing and what type of direct impact does it have?

Fed Funds Rate

The Federal Reserve has control over the federal funds rate. The federal funds rate is a specific interest rate that dictates the interest rate charged on funds borrowed overnight by major financial institutions. Because the fed funds rate only applies to a limited number of institutions and extremely short-term (overnight) loan durations, the rate is typically relatively low. Today, the fed funds rate stands at just 0.75 percent, but traders anticipate it could rise up to 1.75 percent this week.

The fed funds rate peaked at around 5.25 percent in 2007 prior to the Financial Crisis and has remained historically low for most of the years since.

Related Link: The Implied Probability Of A March Rate Hike Just Hit 100%: Winners & Losers

While the fed fund rate doesn’t directly impact most Americans, it certainly has an indirect impact. The Fed uses interest rates as a way to keep inflation in check. In other words, higher interest rates are likely to keep prices from rising too much at the supermarket.

Impact On Credit Cards

While the Fed doesn’t have any jurisdiction over credit card companies like Visa Inc V or Mastercard Inc MA, these companies often set their variable credit card interest rates as a function of the fed fund rate. The same can be said for certain auto and mortgage lenders as well, meaning variable-rate mortgage or auto loans could be getting slightly more expensive.

For savers, higher interest rates are great news. The interest rates banks offer for certificates of deposit (CDs) are also usually set in relation to the fed funds rate. Today, U.S. savers are only getting an average of 1.25 percent interest on a one-year CD.

So while the Federal Reserve’s interest rate decision may seem like something that only impacts banks and economists, this week’s news could have a very real impact on the lives of every American. According to the CME Group, the fed fund futures market is now pricing in a 95.2 percent chance of a March rate hike in the 0.75-1.0 percent range.