Fed Funds Rate

What the heck is the fed funds rate. Why do we care?

Author

Glenn Groves
September 16, 2024

INDUSTRY
What Is The Fed Funds Rate

The Federal Funds Rate plays a critical role in the broader economy because it influences several key financial areas:

  1. Short-term interest rates: It directly impacts interest rates on short-term loans, such as personal loans, credit cards, and auto loans. When the Fed Funds Rate increases, these rates typically rise as well, making borrowing more expensive.

  2. Savings accounts and CDs: Banks often adjust the interest rates they offer on savings accounts and certificates of deposit (CDs) based on the Fed Funds Rate. Higher rates can encourage more saving as returns on deposits increase.

  3. Treasury yields: The Fed Funds Rate can affect yields on U.S. Treasury securities, which in turn influence longer-term rates like those on mortgages and corporate bonds. Treasury yields often serve as benchmarks for other interest rates.

  4. Inflation control: By raising or lowering the Fed Funds Rate, the Federal Reserve can help manage inflation. Raising rates generally slows down borrowing and spending, reducing inflationary pressures. Lowering rates can stimulate economic activity by making borrowing cheaper.

  5. Employment levels: The rate also affects business investment decisions. Higher borrowing costs can lead businesses to slow down hiring or expansion plans, while lower rates encourage investment and hiring, impacting overall employment levels.

  6. Stock market: The rate can indirectly affect the stock market. Lower rates make borrowing cheaper for companies, potentially boosting profits and stock prices. Conversely, higher rates might lead to lower profit margins and reduced stock prices.

  7. Foreign exchange rates: The Fed Funds Rate can influence the value of the U.S. dollar against other currencies. Higher rates tend to attract foreign investment, strengthening the dollar, while lower rates can weaken it.

While the Fed Funds Rate directly controls interbank lending rates, it indirectly impacts consumer borrowing, saving, inflation, employment, stock markets, and the global economy.

Notice what is not listed here? Long-term debt, like mortgage interest rates.

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