Fed Funds Rate

The federal funds rate is the interest rate at which banks lend reserve balances to each other overnight. The Federal Open Market Committee (FOMC) sets a target range for this rate, which currently serves as the primary instrument of U.S. monetary policy.

The Fed raises the funds rate to tighten financial conditions and cool economic activity (fighting inflation), and lowers it to ease conditions and stimulate growth (fighting recession). These decisions ripple through the entire yield curve:

  • Short-term yields (3-month, 6-month, 1-year) track the Fed funds rate closely
  • Intermediate yields (2-year, 5-year) reflect expected policy over the next several years
  • Long-term yields (10-year, 30-year) incorporate expected policy, term premium, and inflation expectations

The FOMC meets eight times per year. Between meetings, the fed funds futures market prices the probability of rate changes, making it possible to extract the market's expected policy path.

The zero lower bound (ZLB) constrains how far the Fed can cut. During the 2008 financial crisis and the COVID-19 pandemic, the Fed held rates near zero and turned to unconventional tools (quantitative easing, forward guidance) to provide additional stimulus. The post-2022 tightening cycle brought rates to the highest level since 2007.

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Related Terms

  • Yield Curve — A line plotting Treasury yields across maturities from short-term bills to long-term bonds.
  • Term Premium — The extra yield investors demand for holding longer-maturity bonds over rolling short-term debt.
  • Yield Curve Inversion — When short-term Treasury yields exceed long-term yields, often signaling recession risk.