What is the federal funds rate?

The federal funds rate is the interest rate that depository institutions charge each other for overnight loans of reserves held at the Federal Reserve. The Federal Open Market Committee (FOMC) sets a target range for this rate, and it serves as the anchor for nearly all short-term interest rates in the US economy.

When the Fed raises the funds rate, borrowing becomes more expensive across the board. Mortgage rates, credit card rates, auto loan rates, and corporate borrowing costs all move higher in response. Conversely, cutting the funds rate loosens financial conditions and encourages lending, spending, and investment.

The mechanism works through the banking system's reserve market. Banks are required to maintain certain reserve balances, and at the end of each business day some banks have excess reserves while others fall short. The federal funds rate is the price that clears this market. The Fed influences this price by adjusting the supply of reserves through open market operations and by setting the rate it pays on reserves (IORB).

Since 2008, the Fed has set a target range (for example, 5.25%-5.50%) rather than a single target. The effective federal funds rate (EFFR) is the volume-weighted median of actual overnight transactions and typically trades within this range. Changes to the target range are announced after each FOMC meeting and are among the most consequential events in global financial markets.

Understanding the federal funds rate is essential for anyone tracking the economy or financial markets. It directly influences the yield curve, shapes expectations for growth and inflation, and affects asset prices from bonds to equities to cryptocurrencies. When the Fed signals rate changes through its dot plot or forward guidance, markets reprice aggressively in anticipation.