Real Fed Funds Rate Higher for Fourth Straight Month

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 the rate of inflation has been higher than the interest rate.

According to the CPI, the annual rate of inflation, now 1.5%, in December increased for the second month in a row. Despite the slight uptick in the rate of inflation, the real Fed funds rate has moved higher (become less negative) each of the last four months. As the real Fed funds rate climbs this makes goods, such as homes and durable goods, more expensive. However, despite the rising level of the real Fed funds rate, the year-over-year change in the rate continues to fall. It is has reached its lowest level September 2012. This slowing rate of change should be positive for housing permits and durable goods spending.

The nominal rate is essentially fixed at zero by the Federal Reserve. So, the only way the real rate can change is due to a change in inflation. The Fed would like price inflation to rise, which would lower the real rate. However, despite all of the Fed's money printing, price inflation is not hitting the Fed's target if 2.0%. Over the next year if inflation stays where it is now, then the change in real Fed funds rate is going to stay relatively flat. This means that the directional change of rates would no longer be supporting further spending on homes or durable goods.

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.