Note: As of September 20, 2019, the interest rate on the Wealthfront Cash Account is 2.07% APY. Read more about it here.
Last week, the Federal Reserve surprised most people by saying it was considering decreasing the federal funds rate (the interest rate at which banks lend money to each other, and the basis for most consumer interest rates). The announcement came as a surprise because as recently as a month ago, the Chairman of the Fed, Jerome Powell, said he saw no reason to change rates.
The fed funds rate influences nearly every financial institution, and a rate decrease directly impacts consumers. The good news: when the rate goes down, mortgage rates go down. The bad news: high yield savings account rates and Certificate of Deposit (CD) rates go down, too. Unfortunately that includes Wealthfront cash accounts as well.
How the Fed determines the target federal funds rate
The Fed uses the fed funds rate as a way of smoothing out economic performance. Jerome Powell made the surprise announcement last week because he and his fellow Fed Board of Governors were worried that current (China) and potential (Mexico) trade wars could have a damaging effect on the economy. The Fed targets higher rates when it is concerned the economy is overheating (which may lead to inflation), and it lowers rates when the economy is slowing down as a way to maintain growth. The premise behind these moves is that cheaper credit encourages companies to borrow, which fuels growth. More expensive credit discourages borrowing, which slows growth.
During the financial crisis from 2007-2008, the Fed lowered its target fed funds rate from 5.25% to a range of 0.00–0.25%. It effectively couldn’t lower its rate any further, which meant it had very few tools remaining to enhance economic growth. As the economy recovered over the past 10 years, the Fed raised its target rate to the current 2.5%. There are some pundits that encourage the Fed to raise its rates even higher so it has more room to drop rates during a bad economy. The Fed does not agree with this philosophy.
How a rate decrease could impact Wealthfront clients
The Fed provides a target range for the fed funds rate, and the actual rate changes based on daily demand and supply of borrowing needs among banks. Over the past three months, for example, the Fed funds rate has varied from 2.37% to 2.45% (source).
When the daily fed funds rate increases within the range to a higher steady rate, Wealthfront’s Program Banks — the banks where we place your cash account funds — raise their wholesale rates, which we then pass along to you. That was how we first increased our rate from 2.24% to 2.29% APY one month after introducing our cash accounts. We then decided to raise the interest rate again, to 2.51% APY, based on our fundamental belief that your money should be making money for you, not for your bank. Passing more on to our clients is in our company DNA.
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