Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Stock Market Brief in Count Down to US Election Result 2024 - 3rd Nov 24
Gold Stocks’ Winter Rally 2024 - 3rd Nov 24
Why Countdown to U.S. Recession is Underway - 3rd Nov 24
Stock Market Trend Forecast to Jan 2025 - 2nd Nov 24
President Donald PUMP Forecast to Win US Presidential Election 2024 - 1st Nov 24
At These Levels, Buying Silver Is Like Getting It At $5 In 2003 - 28th Oct 24
Nvidia Numero Uno Selling Shovels in the AI Gold Rush - 28th Oct 24
The Future of Online Casinos - 28th Oct 24
Panic in the Air As Stock Market Correction Delivers Deep Opps in AI Tech Stocks - 27th Oct 24
Stocks, Bitcoin, Crypto's Counting Down to President Donald Pump! - 27th Oct 24
UK Budget 2024 - What to do Before 30th Oct - Pensions and ISA's - 27th Oct 24
7 Days of Crypto Opportunities Starts NOW - 27th Oct 24
The Power Law in Venture Capital: How Visionary Investors Like Yuri Milner Have Shaped the Future - 27th Oct 24
This Points To Significantly Higher Silver Prices - 27th Oct 24
US House Prices Trend Forecast 2024 to 2026 - 11th Oct 24
US Housing Market Analysis - Immigration Drives House Prices Higher - 30th Sep 24
Stock Market October Correction - 30th Sep 24
The Folly of Tariffs and Trade Wars - 30th Sep 24
Gold: 5 principles to help you stay ahead of price turns - 30th Sep 24
The Everything Rally will Spark multi year Bull Market - 30th Sep 24
US FIXED MORTGAGES LIMITING SUPPLY - 23rd Sep 24
US Housing Market Free Equity - 23rd Sep 24
US Rate Cut FOMO In Stock Market Correction Window - 22nd Sep 24
US State Demographics - 22nd Sep 24
Gold and Silver Shine as the Fed Cuts Rates: What’s Next? - 22nd Sep 24
Stock Market Sentiment Speaks:Nothing Can Topple This Market - 22nd Sep 24
US Population Growth Rate - 17th Sep 24
Are Stocks Overheating? - 17th Sep 24
Sentiment Speaks: Silver Is At A Major Turning Point - 17th Sep 24
If The Stock Market Turn Quickly, How Bad Can Things Get? - 17th Sep 24
IMMIGRATION DRIVES HOUSE PRICES HIGHER - 12th Sep 24
Global Debt Bubble - 12th Sep 24
Gold’s Outlook CPI Data - 12th Sep 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

How Low Will the Fed Funds U.S. Interest Rates Go

Interest-Rates / US Interest Rates Nov 12, 2008 - 01:23 PM GMT

By: Hans_Wagner

Interest-Rates On Wednesday October 29th, the Federal Reserve lowered the Fed Funds rate by 50 basis points to 1.0%. This comes on top of an earlier rate reduction on October 8, 2008 of 50 basis points. The rate is now at the level former Fed Chairman Alan Greenspan kept during 2003 and 2004. This raises the question can and should the Fed lower rates further?


What are the Benefits of a Lower Fed Funds Rate

The spread between the Fed Funds rate and other short-term rates is wide, reflecting the lack of sufficient capital by many banks. Further, the rising default rate by borrowers leads to wider spreads, as the banks that are lending are requiring higher rates to help account for the elevated risk. Should the Fed lower the Fed Funds rate another 50 basis points to 0.50%, it will lower the interest costs for the banks that use the overnight lending rate. In the past when the Fed lowered the Fed Funds rate, other longer-term rates tended to fall as well. For an economy that is struggling, lower borrowing costs should help to mitigate the affects of the recession and encourage it to recover.

Lowering the Fed Funds rate does not directly reduce the spread. The spread will narrow when confidence returns to the credit markets. It will take some time before this change in psychology will finally help reduce rates. Until then borrowers must wait for lenders to find the capital strength to increase their lending.

What are the Risks of a Lower Fed Funds Rate

In 2003-2004, the Fed under then Chairman Alan Greenspan's leadership kept the Fed Funds rate at 1.0%. Recently, that strategy has been blamed for inflating the housing market and causing the excesses in the credit market that led to the current crisis. If rates are below 1.0% and kept there, we could be sowing the seeds of another bubble in the future.

Ordinarily, the Fed can keep the Fed Funds rate on target by adding or draining reserves from banks. The liquidity operations of the Federal Reserve have left banks with billions of excess reserves to lend out, forcing the Fed Funds rate well below target on most days. The Fed now pays interest on reserve deposits at 35 basis points below the Fed Funds rate target. Therefore, banks will leave reserves at the Fed once the market rate on Fed Funds falls to that deposit rate, which is the new de facto target. The Fed wants to maintain a 35 basis point spread between what it pays on reserves and the Fed Funds target rate. This will make it hard to get the funds rate target much below 0.5%.

If the Fed did set a zero Fed Funds rate, this action might encourage banks to leave their money at the Fed rather than lend it to each other, causing the Fed Funds market to dry up. Just the opposite of what the Fed wants to happen.

An unintended consequence of a Fed Funds rate below 1.0% would make it hard for money market mutual funds to pay a competitive yield and cover their operating expenses. If money market rates fall any further, money would flow out of money market funds and into government-guaranteed bank deposits, straining bank capital ratios.

The Bottom Line

The Fed is not likely to lower the Fed Funds rate below the current 1.0% rate. The consequences of lowering the rate further tends to worsen the current credit and money flow problems that the Fed is trying to correct. As a result, the Fed Funds rate is likely to remain at 1.0% rather than go any lower.

If you wish to learn more about analyzing the key factors that drive the economy, I suggest reading:

Economic Growth. by David Weil. An easy to read book that presents the key factors to understand global economies. It is expensive and is used as a textbook for college students, but it is worth the money.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Copyright © 2008 Hans Wagner

Hans Wagner Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

johnnyrodd
21 Mar 10, 16:03
fed funds

with the fed fund srate now at 0-25 it looks like you don't know what the hell you are tslking about now do you?


Post Comment

Only logged in users are allowed to post comments. Register/ Log in