Tuesday, October 07, 2008

The Fed Has Cut Interest Rates

When people say the Fed has cut (or raised) interest rates they refer to the Fed funds rate. The Fed funds rate however could mean two different things: the target rate and the effective rate. Usually when the media refer to the Fed funds rate they refer to the target rate, yet that rate is in fact of no importance at all except as the guide by which the Fed uses open market operations to control the effective rate at which banks actually exchange funds through the Fed. What really matters is the effective rate. Until mid-September, the effective rate was essentially the same as the target ratem give or take a few basis (0.01%) points. Then something really strange happened.

First it spiked to between 2.5% and 3% for two non-consecutive days, only to settle at first about 1.5%, then about 1%. See it for yourself here (scroll down to the bottom of the page), the effective Fed funds rate has been cut to 1%. This unannounced yet still effective 100 basis point interest rate cut by the Fed is most likely related to the extraordinary monetary statistics I recently told you about. The Fed is determined to drown the banking system with money with any means possible short of helicopters (although that may come later).

On the other hand, most market interest rates (including LIBOR) have risen (some dramatically) during that same period. These divergent interest rate trends illustrate my previous point about the "battle" between the inflationary injections by the Fed and the deflationary effects of the increased risk aversion and financial distress.

2 Comments:

Blogger pej said...

Very interesting discovery! Thanks for sharing it.

10:57 AM  
Blogger JS said...

There's another chart here, that shows the high and low rates, along with the standard deviation:

http://www.newyorkfed.org/markets/omo/dmm/fedfundsdata.cfm

1:35 PM  

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