A Phantom Rate Cut

The Federal Reserve sets the Fed Funds Rate and uses open market operations to keep the rate as close to the targeted rate as possible. The targeted rate has been set at 5.25% since July of last year. Since then 14 months have elapsed and the daily effective federal funds rate over those 14 months has been kept incredibly stable. In fact in 8 of those months the effective rate was exactly 5.25%. In 3 of the months the effective rate was 0.01% above the targeted rate and in 2 of the months the effective rate was 0.01% below the targeted rate. All in all, the New York Fed did a phenomenal job of controlling the rate using open market operations.

Then came August . . .

Somehow the effective federal funds rate in August was 5.02%. This would be fine if the Fed had cut the targeted rate to 5%. Yet the targeted rate still sits at 5.25%. Much has been made in the blogosphere of this "phantom" rate cut. And much of what they say is true: in reality, even though unannounced, the markets have had their rate cut for over a month. In fact if the Fed fails to cut rates on September 18th and we see the effective rate drift up towards 5.25% again that will be the equivalent of a rate increase . . . something the markets would undoubtedly not respond well to!

You can check out the effective federal funds rate data yourself on the Federal Reserve website.