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Real Federal Funds Rate: Hikes with Teeth

Posted By Barry Ritholtz On August 11, 2005 @ 6:30 am In Economy,Fixed Income/Interest Rates | Comments Disabled

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 [1]"

"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 [2] reference?


No Stairway [1]
August 4, 2005; Page C1

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2005/08/real-federal-funds-rate-hikes-with-teeth/

URLs in this post:

[1] No Stairway: http://online.wsj.com/article/0,,SB112311571060604538,00.html?mod=Ahead+of+the+Tape

[2] Wayne’s World: http://www.imdb.com/title/tt0105793/

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