Economic News Blog
Posted by: Steven Kline, Jr. 16. May 2014

Real Fed Funds Rate Falls for First Time since August

The real Fed Funds rate was -1.38% in April 2014. The real rate fell 6 basis points (0.06%) from last month. This is the first time the rate has fallen since August 2013. However, the real rate has fluctuated in a very narrow band since October 2013 and has not changed significantly since April 2013. The year-over-year change in the Fed funds rate has been falling since April 2013. In April 2014, the real rate was just 16 basis points higher than it was one year ago compared to 158 basis points in April 2013. This decelerating growth in the real rate should provide a temporary boost to spending on goods purchased with debt (housing and consumer durable goods in particular). 

The real Fed funds rate is likely to provide only a temporary boost for a couple of reasons. First, the nominal rate set by the Federal Reserve is virtually zero and cannot go any lower. And, the Federal Reserve has begun to hint that rates are going to rise at some point in the next year or two. An increase in the nominal rate would cause the year-over-year change in the real rate to rise (everything else being equal).

Second, the annual rate of inflation, according to the CPI, reached its second highest level since February 2013 this month. The rate of inflation was nearly 2.0%. However, while this is the Federal Reserve's stated goal for the rate of inflation, it has been unable to keep the rate of inflation close to that level on a monthly basis. But, if the Federal Reserve could keep inflation running at an annual rate of 2.0% and the nominal rate stayed near zero, then the year-over-year change in the real rate would bottom out around the end of the year. Although, the magnitude of the change would not be that great. However, if inflation runs closer to its average of 1.5%, then the real rate will hardly fall at all from where it currently stands.

Therefore, unless the Federal Reserve can keep inflation running at a rate of at least 2.0%, the real Fed funds rate will no longer be a positive indicator for housing, consumer durable goods spending, manufacturing, and capital equipment spending.

The real Fed funds rate is an important leading indicator for the following industries: appliances; automotivecustom processorsfurniture manufacturinghardwareHVACmetalcutting job shopsoff-road and construction machinerypetrochemical processorsplastics and rubber; pumps, valves, and plumbing productstextiles, clothing, and leather goods; and wood and paper.

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