Wsj_8032005201855One of the differences between the prior 9 hikes and yesterday’s (as well as future hikes) has been the Real Federal Funds Rate. Its now above zero. Meaning, the Fed Rate of 3.5% is above inflation.

Prior rate hikes were actually still stimulative, with each hike leaving the Fed Funds rate "accomodative" — only 25 basis points less so than before.

It was like a big bowl of candy was sitting on the Fed cocktail table, and each FOMC meeting, they removed a few pieces.

The Candy was still there, but a there was a little less each time.

Now, however, we are no longer in accomodative territory. Each hike no longer means a bit less pleasure — now, the Fed has taken out the paddle and with every hike, they are swatting all of us on our collective arses.

We have transitioned from a Fed giving us a little less pleasure each hike, to a little more pain.

I expect the repurcussions for this will be significant.

This was mentioned last week in a WSJ ccolumn titled "No Stairway"

"Three steps and a stumble" is the old Wall Street saying on what happens to stocks when the Federal Reserve raises interest rates. But even though the Fed has been stepping up the overnight target rate it charges banks for more than a year, the stock market’s footing seems sound. . . 

An additional factor behind stocks’ Teflon-like reaction to the Fed, says John Bollinger of Bollinger Capital Management, is that the funds rate only recently rose above the rate of inflation as measured by the consumer-price index. In June, the real federal-funds rate — the funds rate minus the rate of inflation — came to 0.5%. That is a little below where it was in 1994, right before the Fed started increasing rates.

A negative real funds rate creates a strong incentive to borrow money to buy goods and services, since those things will cost more in the future than it will cost to repay a lender. It brings lots of cash sloshing into the economy — cash that can be used for buying not just goods, but houses, Treasurys and, of course, stocks.

Mr. Bollinger thinks that now that the Fed has brought the real funds
rate into positive territory, investors should become a bit more
cautious. But after seeing so many rate increases come and go with no
effect, that might be a tall order.

Hey Justin — is the title a Wayne’s World reference?

Denied!

Source:
No Stairway
AHEAD OF THE TAPE
By JUSTIN LAHART   
August 4, 2005; Page C1
http://online.wsj.com/article/0,,SB112311571060604538,00.html?mod=Ahead+of+the+Tape

Category: Economy, Fixed Income/Interest Rates

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

4 Responses to “Real Federal Funds Rate: Hikes with Teeth”

  1. Cynical Investor says:

    . . .
    Now, however, we are no longer in accomodative territory.
    . . .
    . In June, the real federal-funds rate — the funds rate minus the rate of inflation — came to 0.5%.
    . . .

    Is it really accurate to say a real federal funds rate of .5 (or .75) percent is no longer accomodative?

  2. knzn says:

    I would answer “no” to Cynical Investor’s question. However, I also think it is wrong to use a simple lagging inflation rate to measure the real FFR. The past year has experienced rising energy prices that are not forecast to continue. Using a smoothed inflation rate, the real FFR is closer to 1% right now, which is well within the normal range, though probably not dead-on neutral. (The historical average is about 1.8%.)

  3. Robert Goldschmidt says:

    Anyone who believes that the inflation rate is anything close to 3% must be smoking something stronger than I can handle. Well back in the Clinton administration, the Federal economists stepped away from the basket of goods approach in order to avoid getting buried by Social Security increases. I propose a new measure. What it takes for middle income America to live as well as they did the previous year.

    If economists would step away from their keyboards and talk to the people who make up the basis of our economy, they would find that a typical middle income American is losing buying power each year at the rate of an additional $100 to $200 a month.
    The Fed has used this conveniently low CPI calculation to cool off inflation and interest rates by generating an artificial negative expectation. There’s just one catch, it is being done on the backs of middle income America. The results of continuing down this path are that more and more middle income families are losing hope. Hope that there children will live better than they did. Hope that they can afford to put their children through state college. Hope that they can live in retirement in minimal comfort.

    The class of downtrodden people we are generating will be the ones who sign up to fundamental religions, will follow demagogues and will ultimately change our society into one more like the Phillipines.

    Lets wake up. Why doesn’t some economist look at the true costs of living for the typical middle class family.

  4. Bruce says:

    On the other hand, since the CPI is a highly “juiced” (per Mr. Ritholz and others) figure, we are arguably still in accomodative territory until the FFR goes up another 100 basis points or so.