Economic News Blog
Posted by: Steven Kline, Jr. 17. July 2013

Real Fed Funds Rate Going Lower

The Fed funds rate is the earliest leading indicator of the durable goods industry and capital equipment spending. Typically, changes in the Fed funds rate lead changes in capital equipment spending by several years. Historically, I've used the Fed funds rate to indicate the direction of housing permits and consumer durable goods spending because both houses and durable goods are almost always bought with debt. Therefore, as rates go down, both houses and durable goods become relatively more affordable and consumers buy more of them. 

However, since the Fed funds rate has been essentially zero since December 2008, the real Fed funds rate has become a better leading indicator. The real Fed funds rate is simply the Fed funds rate minus inflation. Even though nominal rates can't go below zero, the Federal Reserve can push real rates below zero if price inflation is greater than the interest rate. Since March 2010, the real Fed funds rate has been negative because inflation has been higher than the interest rate. 

The annual rate of inflation has increased slightly the last two months, moving to 1.8% from 1.1%. This has helped push the the real Fed funds rate lower the last two months. The current rate is now negative 1.6%. Compared to one year ago, the change in the real Fed funds rate has increased at a slower rate the last two months. The rate of increase is now at the slowest rate since December 2012. In the short term, this is a positive sign for durable goods production and capital equipment investment in 2014 and 2015. However, a healthy economy would not see negative real rates.

The Fed funds rate is an important leading indicator for the following industries: appliances; automotive; custom processors; furniture manufacturing; hardware; HVAC; metalcutting job shops; off-road and construction machinery; petrochemical processors; plastics and rubber; pumps, valves, and plumbing products; textiles, clothing, and leather goods; and wood and paper.

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