Is the Federal Reserve firing empty-handed?

The Federal Funds Rate (FFR) set by the Federal Reserve – The The interest rate that everyone obsesses over is a strange creature. It is not what it may seem or what many people assume.

1. First of all, it is no actual interest rate tied to every real loan – the FFR is one Goal, no one is legally obliged to comply with them.
2. The goal only applies to Interbank loans – for banks in the Federal Reserve System that may from time to time lend or borrow reserves from one another
3. The target only applies to the shortest short-term loans – it is a target for overnight Loan interest

The FFR is actually more of a polite suggestion. It only applies to a very narrow category of loans, which, when they actually occur, are transfers of funds that remain entirely within the closed system of reserve accounts deep within the Fed itself. The motivation for these transactions is generally regulatory rather than economic. They are intended to ensure compliance with the Fed’s own reserve requirements. The FFR does not apply to genuine loans to businesses or consumers.

However, this peculiar insider game involving the manipulation of an ultra-short-term goal does appear to promote changes in the general interest rate system that regulates the flow of credit in the real economy. The FFR generally appears to cause economically important long-term interest rates to converge in a directional manner. Over the past five years, 10-year Treasury yields have risen and fallen in lockstep with the Federal Reserve’s interest rate targets. The correlation is 92%. The same goes for 30-year fixed-rate mortgage rates, which had a 94% correlation with FFR.

This could suggest that the Federal Reserve actually has a powerful and precise tool for influencing key long-term interest rates – the fundamental myth on which the Fed’s credibility rests. The previous column detailed the hollowness of this myth. The Fed’s ability to influence the real economy has been completely overstated. Instead, we have a kind of trust game in which the Fed’s power is a matter of belief – as long as we believe in it, the illusion will remain effective.

Until recently, this belief was strong. The synchronization process has extended to the stock market itself, which has shown extreme sensitivity to Fed announcements, potential announcements, redacted minutes and the language used by leadership in various press briefings. This has led to a significant clustering of stock returns around the days the Federal Open Market Committee meets.

This is extraordinary. There are only eight regularly scheduled FOMC meetings per year. If these eight days are removed, the S&P 500’s gains on the other 347 days of the year will be significantly reduced.

[Note that this effect only appeared in the Greenspan years, where – arguably — an important shift in Fed communications policies emerged, aimed more explicitly at influencing the financial markets. Of course, this was never part of the Fed’s mandate, and there are many who view this innovative new mission with skepticism.]

Is that healthy? Is it sustainable? And what happens if Believe get stuck at some point? These are important questions. And there may be a hint of doubt at the moment, following the recent, long-awaited cut in the FFR target.

The rate cut of September 16th

On September 16, Jerome Powell announced a 50 basis point cut in the federal funds rate, as described in a previous column. It was the first cut in more than four years. It was seen as an “emphatic” turnaround that signaled a shift toward easing monetary policy that would see interest rates begin to fall across the board, likely providing stimulus for a weakening economy. The intent was clear: the Federal Reserve wanted to start driving down borrowing costs.

But this time the markets did not follow the Fed’s “suggestion”. Real interest rates in the real economy Rose, quickly and significantly. The 10-year Treasury yield rose 40 basis points to close above the significant 4% mark today (October 7).

Meanwhile, 30-year fixed-rate mortgage rates rose 58 basis points as of October 4.

Consider the separation here. The Federal Reserve dropped its target interest rate by 50 basis points while still maintaining market-based benchmark interest rates increased by more or less the same amount. The “spread” between the key interest rate and the market interest rate increased by a full percentage point in this three-week period. Applied to the $25 trillion U.S. economy and $46 trillion bond market, that 1 percent represents a huge potential discrepancy.

There is a lesson in this. The Fed’s power to move the credit market is not automatic, as many people assume. Yes, it is likely that market interest rates will trend downward over time. But the truth may have penetrated the illusion here. Is the likely convergence a matter of causation or just correlation? The Federal Reserve and financial markets may both reach a similar conclusion, but that does not confirm the effectiveness of the Fed’s policy moves. At the moment, the independence of the markets is evident, refusing to immediately accept and join the new easing regime.

This is actually not that unusual. Last year (Oct 2023 – Oct 2024), the correlation of Treasury yields with FFR was only 34% (much less than the 5-year average). There was the FFR fixed At 5.25% over this period, this means Treasury yields have risen significantly, reflecting the market’s changing views on the likelihood and importance of various factors Future Events (recessions, soft landings, Fed policy changes) – rather than chaining yourself to the Fed target.

And the year before that (Oct. 2022 – Oct. 2023), when the Fed raised the target rate, correlations between the FFR and both the 10-year Treasury yield and 30-year mortgage rates were even lower, at around 20%. , indicating a very weak relationship.

A full percentage point of “unfavorable” financial market reaction to the Fed’s proposal is at least a little shocking. This is another weak point in the Fed’s armor, even if interest rates do eventually converge. It appears that the Fed’s most important asset – its credibility – may be in jeopardy. Even the sober citizens who process it Washington Post are worried. “The Federal Reserve’s greatest resource is its credibility. People have to believe…” And if faith weakens, “the central bank won’t survive.” That’s right Posts Concern here has focused on questions about personal transactions by Fed officials, but the types of disruption that can threaten public trust in the institution are varied. Public confidence in the Federal Reserve is at or near all-time lows today, and these small signals of the market’s apparent disregard for the Fed’s intentions should not be ignored.

For more information on this topic, see

ForbesThe Fed’s interest rate cut: A “soft landing” – or “fake news”?From George Calhoun
ForbesThe Fed doesn’t just print money, it also prints alphaFrom George Calhoun