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Fed Funds Spread Signals Crash
By iTulip Administrator
15/09/08 "iTulip"
-- - The last time the Fed Funds target rate got this out of line
with the effective rate was in 1987, and from a base of over 6%
not 2%. On a percentage basis, at three times the target rate
the spread is unprecedented. It happened today.
Fed funds jump to 6 pct in mkt, tripling Fed's target
NEW YORK NEW YORK, Sept 15 (Reuters) - Federal funds traded
in the U.S. interbank lending market were indicated to have
jumped to 6 percent on Monday, tripling the target rate of 2
percent which the Federal Reserve sets.
The move happened even after the Federal Reserve earlier
added $20 billion of temporary reserves to the banking
system via overnight repurchase agreements.
Early Monday, at around 7:10 a.m. EDT in New York, federal
funds had traded at 2.0625 percent. When market inter-bank
lending rates shoot up, that often reflects distrust among
financial institutions of lending to some other
counterparties. Global market participants' risk aversion
has surged on Monday as the U.S. banking crisis has
escalated, analysts say.
AntiSpin: The Fed tries to
manage the economy and inflation by influencing short term
interest rates. It does that by buying and selling government
bonds in the bond market in what are called "open market
operations." They set a target rate, such as 2%, then buy or
sell bonds as needed until the effective rate in the bond market
matches the target rate objective. Problem is, this process does
not always work in times of crisis because the bond markets
themselves may be dis-functional, as is the case today.
Really, really dis-functional.
In 1987 during the crash the Fed Funds target rate was 6% but
the effective rate jumped more than two times to 16% as banks
lost confidence in lending to each other. Today that spread
looks benign.
On Friday Sept. 12, the effective funds rate was 2.1 percent,
only 10 basis points over the target rate. Now the effective
rate is three times the target rate. What it means is that the
banks are so distrustful of each other's credit that they do not
want to lend to each other. Who can blame them? Lehman Bros.
went out of business today (15/09/08) leaving its creditors holding the bag
to the tune of $630 billion in defaulted debt.
``If the fed funds rate closes high today, I would be really
worried as it would mean that there really is no money out
there to be lent,'' said Stan Jonas, who trades interest-
rate derivatives at Axiom Management Partners LLC in New
York.
- Bloomberg
These episodes usually don't last long. It will be interesting
to see what happens next.
Today's mega spread between the Fed target and effective rate
has not shown up in the Fed's graph yet today.
Look for it tonight or tomorrow.
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