Saturday, March 13, 2010

ALERT: Effective Fed Funds Rate Still Climbing; Could Be Signal of Fed Interest Rate Hikes Much, Much Sooner than Most Expect

The effective Fed Funds rate closed the week at 0.18%. At the end of February it closed at 0.13%. Have some bankers finally figured out they can arbitrage the difference between the Fed funds rate and the rate the Fed is paying on excess reserves (IOER)? As of the end of February,  excess reserves continued to climb, so this is a possibility.The alternative explanation is that it is new real demand for Fed funds.

The current Fed funds target range is 0.0% to 0.25%, if this is banks arbing the spread, the Fed Funds rate is likely to stop just short of 0.25%. If it is real new demand for funds, 0.25% is in danger of being pierced to the upside. At 0.25% the Fed is likely to add reserves but, this would be extremely inflationary.

The only alternative is to hike the IOER and the Fed Funds rate.

Watch the effective fed funds rate, if it gets close to 0.25% (and it is moving towards this rate at roughly a basis point every other day), and it is caused by real new demand for Fed funds, the Fed could be forced to raise the IOER and FFR much sooner than most analysts expect. It would be a signal that the market is pushing the Fed. We could be talking weeks instead of months. The Feds vision of hiking rates sometime in late 2010 would be dust. Do you want to see panic? Watch the market force the Fed into hiking IOER and FFR much, much sooner than anyone expects.

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