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Does the Fed “control” short rates?

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This seems to be common wisdom but I have seem some good arguments that it is a myth. The argument I see is a graph showing that movements in the Fed Funds lags the movement in T-Bills. In other words the fed is generally following the market with the exception of a period under Vocker where he was fighting embedded inflation.

It is also interesting that the Fed doesn’t seem to be at all present in Bill auctions at the moment as they have changed the maturity of their holdings.

What do you think Cullen? Is it possible that this is an urban myth.

The Fed has the power to intervene in markets and control rates but the operational reality appears to be that it mostly is operating at the margins and not too heavily influencing market rates.

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Posted by Lee Colville
Posted on 04/11/2017 3:23 AM
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Regulators and political authorities generally do follow the market in almost everything.

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Posted by Suvy Boyina
Answered on 04/11/2017 3:33 PM
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    This one is pretty cut and dry. The Fed absolutely controls the rate in overnight lending by setting the interest on excess reserves. This is the benchmark rate from which all other short-term rates are set. So, they might not “control” T-Bill rates, but they have a massive influence on it. What you’re seeing when you see a chart of T-Bills leading overnight rates is really an anticipatory market effect. The market is front-running the Fed’s next move. This is typical of any market, but we shouldn’t confuse it to mean that the market is setting the overnight rate. It is quite the opposite.

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    Cullen Roche Posted by Cullen Roche
    Answered on 04/11/2017 3:36 PM
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      I thought that too once but Roche set me straight! Correlation is not causation.

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      Posted by MachineGhost
      Answered on 04/11/2017 11:26 PM
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        Thanks Cullen. So this is basically broker/dealers making sure they don’t get caught with their pants down when overnight lending rates rise. And when there is no spread between the T-Bills and the Fed Funds rate then I guess it is pretty much a given that changes to the Fed Funds rate are going to be reflected in T-Bills, Commercial paper etc.

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        Posted by Lee Colville
        Answered on 04/12/2017 3:58 AM
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