Why the Federal Funds Rate matters to us?
The Federal Reserve System implements monetary policy largely by targeting the federal funds rate. This is the interest rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed.
What's the Federal Fund Rate?
The federal fund rate is actually determined by the market and is not explicitly mandated by the Fed. The Fed, therefore, tries to align the effective federal funds rate with the targeted rate by adding or subtracting from the money supply through open market operations.
The Federal Reserve System usually adjusts the federal funds rate target by 0.25% or 0.50% at a time.
Why does the Federal Funds Rate matter?
The federal funds rate is one of the most important interest rates in the U.S. economy since it affects monetary and financial conditions, which in turn have a bearing on critical aspects of the broader economy, including employment, growth, and inflation.
The rate also influences short-term interest rates, albeit indirectly, for everything from home and auto loans to credit cards, as lenders often set their rates based on the prime lending rate. The prime rate is the rate banks charge their most creditworthy borrowers and is influenced by the federal funds rate, as well.
Investors keep a close watch on the federal funds rate, too. The stock market typically reacts very strongly to changes in the target rate. For example, even a small decline in the rate can prompt the market to leap higher as the borrowing costs for companies gets lower.
Companies looking to borrow and expand their businesses face higher borrowing costs when the Fed raises rates. Higher borrowing costs lower corporate profit margins.
Many stock analysts pay particular attention to statements by members of the FOMC to try to get a sense of where the target rate might be headed.
This presentation is for informational and educational use only and is not a recommendation or endorsement of any particular investment or investment strategy. Investment information provided in this content is general in nature, strictly for illustrative purposes, and may not be appropriate for all investors. Read more
