That secret Fed rate cut hasn't made it across the Atlantic just yet
Yesterday I posted a chart comparing the intended Federal funds rate set by the Federal Open Market Committee with the actual average interest rate that U.S. banks are charging each other for overnight loans. Since early August, the actual rate has been substantially lower than the intended one. It turned out CondeNast Portfolio blogger Felix Salmon had already posted just such a chart while ago (here's his updated version), so in the interest of actually moving the discussion (chartussion?) forward, I put this together (and Time.com's Feilding Cage made it look good):

LIBOR is the London Interbank Offered Rate, the rate that banks in London charge each other for loans of various (short) durations and the benchmark used in many an adjustable-rate-mortgage. There are Euro and sterling LIBORs; in this case, I use the rate for overnight loans denominated in dollars. It usually tracks the Federal funds rate very closely, but it has spent the last month or so bouncing around well above it, although it appears to be returning to normalcy of late. I'm not well enough versed in the vagaries of interbank lending to tell you exactly what all this means, other than that the efforts of the Fed to calm things down took a while to make themselves felt outside the ten block radius of 33 Liberty Street. Any other ideas?
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1
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
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2
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")
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3
".. invariati" Creo que el mismo. (It's not quite Italian but rough Spanish usually works in Italy)
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4
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. -
5
Thanks, Henri, for clarifying things. Problems with the plumbing system is exactly the apt metaphor, I think.
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