Real Fed Funds Rate Higher for Third 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.

The annual rate of inflation, now 1.24%, in November increased for the first time in three months. However, the annual rate of inflation since September has been lower than every month except one since November 2010. The generally lower rate of inflation has led to the real Fed funds rate moving higher for the third month in a row. However, the year-over-year change in the real rate has fallen since April 2013. This slowing rate of change tends to lead to growth in housing and consumer durable goods spending, both of which are a positive sign for future capital equipment 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 has actually fallen. Over the next year if inflation stays where it is now, then the change in real Fed funds rate will move slightly lower until April 2014. After that, the change in the real Fed funds rate will stay relatively constant. So, unless the Fed can get price inflation to rise, then housing and consumer durable goods spending will lose the boost they get from falling 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.