Definition
Federal funds rate is the overnight interest rate at which depository institutions lend reserve balances to one another, used by the Federal Reserve as a primary instrument of US monetary policy.
Why it matters
The federal funds rate is the most-watched interest rate in the United States because the Federal Reserve sets a target for it as the primary lever of monetary policy. Movements in the federal funds rate propagate through short-term funding markets, the Treasury yield curve, and ultimately the rates available on savings accounts, mortgages, and annuities. The rate is overnight in maturity but its policy significance is that it anchors the entire term structure of dollar interest rates.
How it works
The federal funds rate is the rate that depository institutions charge each other for overnight unsecured loans of reserve balances held at the Federal Reserve. The Federal Open Market Committee sets a target range for the rate at its scheduled meetings, currently the principal monetary policy decision communicated to markets. The actual rate at which banks transact, called the effective federal funds rate, is kept within the target range through administered rates on bank reserves and reverse repurchase facilities. A target range of 5.25% to 5.50% on the federal funds rate, for example, means the Fed is steering overnight bank-to-bank lending to clear within that range. Changes in the target propagate quickly to short-term Treasury bill yields, money market fund yields, and other short-dated dollar instruments, then more gradually to longer-maturity bond yields, lending rates, and the broader cost of credit.
In practice
Individuals do not borrow or lend at the federal funds rate directly — it is an interbank rate. They encounter its effects on savings account yields, money market fund yields, mortgage rates, and annuity payout rates, each with its own lag and pass-through profile. When the Federal Reserve raises the target federal funds rate, annuity payout rates and bond yields generally rise, though not instantaneously and not in lockstep; when the Fed cuts, the reverse occurs. A professional advising on the timing of an annuity purchase or fixed-income allocation should treat the federal funds rate as one of several upstream variables affecting product pricing, not as a direct quote for the product itself.
In the Longevity Standard Framework
Federal funds rate is supporting vocabulary in the Longevity Standard framework. The rate is the most direct policy instrument by which the prevailing interest rate environment is set, and the interest rate environment is what determines the discount rate context within which every cost-of-income comparison is computed. The federal funds rate transmits through to general account investment yields — the asset-side return that supports asset-backed claims — and to the embedded spread that determines the cost structure of insurer-issued lifetime income products. Realized value figures for commercial products move as the federal funds rate moves, because product pricing tracks the prevailing rate environment.
Related terms
- Federal Reserve policy transmission
- Real interest rate
- Nominal interest rate
- Interest rate cycle
- Investment yield
- Spread compression
- Asset-liability management
- Asset-backed claim