American savers are missing out – because bank interest rates are trailing the Fed's benchmark by a record amount

• Banks are struggling to keep up with the Federal Reserve's rapid interest rate hikes, the New York Fed found.
• That means there's a record gap between the rates they offer customers on deposits and the Fed's benchmark.
• That's helped drive a big outflow of deposits from banks to money-market funds, economists said.

American savers aren't seeing much benefit from the Federal Reserve's year of aggressively raising interest rates yet, going by new research by the New York Fed.

The interest rates that banks pay on customer deposits are lagging the US central bank's benchmark by a record amount, its economists said in a new paper.

They found a 2.3 percentage-point difference between the average savings deposit and Federal funds rate at the end of the fourth quarter of 2022 - the largest gap on the record, which stretches back 30 years.

The benchmark was 4.5% as the year closed, suggesting customers were getting around 2.2% average return on their deposits. They totaled $18 trillion at the time.

Economists Alena Kang-Landsberg, Stephan Luck and Matthew Plosser analyzed so-called "deposit betas", which measure how quickly banks pass on interest-rate hikes to their customers.

The Fed has lifted borrowing costs from near-zero to just below 5% over the past year in a bid to tame decades-high inflation. But ordinary lenders have struggled to keep up with the breakneck pace of its tightening campaign, the analysis found.

The record gap could help to explain why Americans have plowed record amounts of cash into money-market funds in recent weeks, according to the New York Fed economists.

Assets in money-market funds hit a fresh high of $5.25 trillion last week, according to data from the Investment Company Institute. The funds invest in short-term, low-risk debt securities, whose yields tend to offer slightly higher returns for customers than parking their cash in a bank account.

"The spread between the Fed funds rate and the deposit rate is at a modern high of above 2%," Kang-Landsberg, Luck, and Plosser said.

"Hence, banks are facing significant competition for savers from other vehicles that offer rates closer to the fed funds rate, such as money-market mutual funds," they added.

News of the big difference between deposit and Federal funds rates comes at a time when regional banks are already reeling from the turmoil caused by the collapse of California lender Silicon Valley Bank in March.

But customers might want to wait before pulling their cash from savings accounts. Deposit interest rates could be set to surge the rest of this year as the gap to the Fed's benchmark starts to close, according to the researchers.

"While deposit rates and deposit betas have continued to rise, they have not outpaced the growth in the fed funds rate - a development suggesting that both deposit rates and betas are likely to continue to rise during 2023," they wrote.

Read more: Investors poured a record $300 billion into money-market funds in just 3 weeks. Here's what they are, and why they're surging in popularity.