That secret Fed rate cut hasn't made it across the Atlantic just yet

Hi to all,

if you have any thoughts on what will the FED do on September, 18th on the light of the recent market turmoil, please feel free to leave your vote on my blog's poll at:

http://www.thedailyeconomist.blogspot.com/

best,

Bernardo

I voted ("unchanged"). But it's much more fun if you do it on Bernardo's Italian-language blog:

http://economistaquotidiano.blogspot.com/

("Lasciera i tassi interbancari invariati")

".. invariati" Creo que el mismo. (It's not quite Italian but rough Spanish usually works in Italy)

Justin, I fear that the rates you are plotting have not much to do with one another. They never meet, not in this world and not even in death.

Fed Funds are overnight funds

1) for same day value, ie from today included to the next business day
2) and are traded in American time
3) between clearing banks in the US.

Overnight Libor is a measuring of rates for funds

1) from today plus two business days to today plus three business days
2) as they are traded at exactly 11am London Time, ie a time when America is still fast asleep
3) between London money center banks.

[The BBA page giving LIBOR definitions is : http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=225&a=1412

Thus, there is no possible arbitrage between those two. The only thing that keeps them loosely linked, in "normal" times, is the anticipation of "normal" market volatility. As funding uncertainties mount, they will just go with where instant flows and urgent needs will put them, ie possibly very wide apart.

In fact, if you had data for O/N dollar trading in Asia earlier on in the day, it would show even much higher volatility and divergence from the Fed Fund rates later on while Asia sleeps. In the aftermath of Sep 11th, under massive funding uncertainties, you had overnight dollar funds reaching 10% at one point in the Asian morning and Fed Funds ending up at 0% in the American afternoon after massive cash injections from the Fed.

So that graph of yours is in fact not measuring absolute levels in target rates but
a) the level of uncertainty prevalent in the interbank market and, sadly,
b) the inadequacy and low quality of the plumbing system (ie the Fed Funds circuit) that the Fed uses to conduct monetary policy in a global world.

Thanks, Henri, for clarifying things. Problems with the plumbing system is exactly the apt metaphor, I think.