Takeaways
- The Federal Open Market Committee (FOMC) sets the target federal funds rate.
- The FOMC meets at least eight times annually to discuss and determine the federal funds rate.
- The target federal funds rate is also called the Overnight Federal Funds Rate.
- Federal funds rates influence the cost of personal loans, mortgages, and credit cards.
- Investors actively monitor the federal funds rate because it can affect the stock market.
What Is the Federal Funds Rate?
The first step to understanding the federal funds rate is to know what the Federal Reserve does. The Federal Reserve was established in 1913 after a series of financial panics and has the express responsibility for managing and guiding monetary policy in the United States. Ultimately, the Federal Reserve has the power to affect the cost of money. That is where the federal funds rate comes in.
The federal funds rate is part of the Federal Reserve’s toolkit for implementing monetary policy. The three main tools are open market operations, the discount rate, and reserve requirements. The federal funds rate is the interest rate at which deposit institutions (e.g., banks) lend reserve balances to other deposit institutions overnight.[1] This rate essentially acts as the lower floor for what banks will lend, thus establishing the baseline for the cost of capital throughout the economy.
The federal funds rate propagates throughout the economy and affects the interest rate charged by credit cards, mortgage rates, and personal loans. In addition to having massive implications for debt products, the federal funds rate also changes what banks and credit unions pay on interest-bearing accounts like high-yield savings accounts, checking accounts, or certificates of deposits.
As rates increase, debt becomes more expensive, and interest-bearing accounts make more interest income. This can all be quite complicated, so let’s look at exactly how the federal funds rate works.
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How Does the Federal Funds Rate Work?
The Federal funds rate is at the nexus of the complex U.S. banking system. Here’s how the federal funds rate works.
Financial institutions are required to hold a certain percentage of their deposits at a Federal Reserve bank. The amount of capital held at a Federal Reserve bank is called a reserve requirement. The reserve requirement protects the financial solvency of the banking institution (e.g., to ensure the bank has enough cash to meet withdrawals and other transactions for its depositors).
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When a financial institution has a surplus of cash in its reserve account held at a Federal Reserve bank, it can lend that capital to other banks that need a larger balance. The federal funds rate is the interest rate charged by a depository institution to lend those excess funds overnight.
While the FOMC has the power to set target rates, it does not have the authority to actually force banks to lend to each other at the exact target rate. However, financial institutions holding their deposits at Federal Reserve banks tend to charge the federal funds rate to other banks in the system. If they don’t oblige the FOMC recommendations, the Federal Reserve can expand or contract the money supply to reduce or increase interest rates.
Financial institutions don’t charge each other the exact rate for overnight lending. Instead, the two banks will agree to an overnight interest rate. The effective funds rate is the weighted average of the interest rate among all transactions of this type.[2]
At each of the eight meetings of the FOMC, the committee decides whether to adjust the federal funds rate. Investors actively watch the FOMC decisions on the federal funds rates because of its implications for the stock market, savings and checking accounts, mortgage rates, credit cards, and other interest-linked financial products.
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What Is the Current Federal Funds Rate?
The FOMC had its last meeting of 2024 in late December and voted to cut the current federal funds rate to 4.25% to 4.5%.
Here is the current federal funds rate:
| FOMC Meeting Date | Rate Change | Target Fed Rate |
|---|---|---|
| December 18-19, 2024 | 0.25% | 4.25% - 4.50% |
How the Federal Funds Rate Affects You
The federal funds rate is a tool for the Federal Reserve to control the machinations of the U.S. economy. As part of the resources for controlling monetary policy, it has a trickle-out effect on the broader economy.
During rising inflation, the Federal Reserve will try to increase interest rates to curb inflation. This percolates through the economy in the form of higher costs of capital. When the Federal Reserve raises the cost of borrowing, banks pass that extra cost onto consumers.
When the federal funds rate increases, banks charge more for lending capital. As a result, debt becomes more expensive to consumers, and the economy generally contracts. Purchases (like home sales) slow, and debt consumption decreases. Additionally, investors can earn more income on interest-earning investments like high-yield savings accounts, checking accounts, certificates of deposits, bonds, and money market funds.
A recent practical example of the power of the federal funds rate is observed in the U.S. housing market. With an increasing federal funds rate, mortgage lenders have had to increase the cost of mortgages. As recently as early January 2021, the average mortgage rate for a 30-year fixed-rate mortgage was 2.65%. That number skyrocketed to 6.62% by early January 2024.[3] The increase in mortgages has kept many prospective homeowners on the sidelines, directly affecting how consumers buy and sell real estate. As a direct result of the FOMC policy change, real estate transactions have plummeted.
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Schedule of 2025 FOMC Meetings
The Federal Open Market Committee (FOMC) meets regularly to discuss economic issues, interest rates, and other financial topics. The FOMC has eight regularly scheduled meetings during the calendar year and supplements these meetings as needed. The minutes from these meetings are released three weeks after any policy decision.
Investors place considerable weight on these meetings and policy decisions because they directly impact debt and equity markets. Rising interest rates can positively affect interest-paying products, while negatively affecting some equity-related products. As interest rates fluctuate, investors shift their holdings to offset risk and return.
For example, in 2022 and 2023, when interest rates rose at the fastest rate in over 40 years, investors shifted more funds into high-yielding savings accounts because they could command interest rates of 5% with low corresponding investment risk.
Below is a table of the FOMC’s scheduled meetings for 2025:
2025 FOMC Meetings
| Month | Date |
|---|---|
| January | 28-29 |
| March | 18-19 |
| May | 6-7 |
| June | 17-18 |
| July | 29-30 |
| September | 16-17 |
| October | 28-29 |
| December | 9-10 |
Source: Federal Reserve [4]
Smart Summary
The federal funds rate is an instrumental and highly watched marker for the health of the U.S. economy. Shifts in the federal funds rate have direct implications on consumer behavior and the health and vitality of the stock market. As one of the more critical pieces of information for professionals in the debt and equity capital markets, expectations about the federal funds rate drive many investment decisions. It is a smart money move to understand how the federal funds rate may affect your investment portfolio, diversification, and long-term capital returns.
Frequently Asked Questions
The Federal Open Markets Committee is tasked with setting the target federal funds rate.
No. The federal funds rate affects how much banks with deposits at a Federal Reserve bank charge each other to lend capital overnight. This sets the floor for the cost of borrowing capital from banks. Banks then charge customers a percentage over this floor to earn a profit
The best high-yield online savings accounts pay an interest rate close to the federal funds rate. Because they can lend at 5.25%, banks will pay consumers less than that amount and keep the difference as profit.
(1) FederalReserve.gov. Open Market Operations. Last Accessed January 20, 2025.
(2) St. Louis Fed. Federal Funds Effective Rate. Last Accessed January 20, 2025.
(3) Freddie Mac. Mortgage Rates. Last Accessed January 20, 2025.
(4) FederalReserve.gov. Meeting calendars, statements, and minutes (2019-2024). Last Accessed January 20, 2025.
