Federal Funds Rate
The federal funds rate is the interest rate at which U.S. commercial banks lend their excess reserves to one another overnight, and it serves as the primary tool the Federal Reserve uses to implement monetary policy.
Banks are required to hold a minimum level of reserves — either in their vaults or on deposit at a Federal Reserve Bank — to meet potential withdrawal demands. On any given day, some banks end up holding more reserves than required while others fall short. The federal funds market allows banks with surpluses to lend to banks with deficits, usually for a single overnight period. The interest rate charged on these loans is the federal funds rate.
The Federal Reserve does not set this rate by decree. Instead, the Federal Open Market Committee (FOMC) announces a target range — for example, '5.25% to 5.50%' — and then uses open market operations (buying or selling Treasury securities) to steer the actual rate into that range. When the Fed buys securities, it injects reserves into the banking system, pushing the rate down. When it sells securities, it drains reserves, nudging the rate up.
Because the federal funds rate is the baseline cost of short-term borrowing in the United States, it ripples outward through the entire economy. Mortgage rates, car loans, credit card rates, corporate borrowing costs, and even deposit yields at savings accounts all move, with varying lags, in the same direction as Fed rate changes. Equity investors care deeply about the fed funds rate because lower rates reduce the discount rate applied to future corporate earnings, boosting stock valuations, while higher rates have the opposite effect.
Following the 2008 financial crisis, the FOMC cut the fed funds rate to effectively zero (a range of 0%–0.25%) and held it there for seven years. During COVID-19 in March 2020, it was again slashed to zero almost overnight. Beginning in March 2022, the Fed embarked on the most aggressive hiking cycle in four decades, raising rates from near zero to a 23-year high of 5.25%–5.50% by mid-2023 in an effort to tame inflation that had surged above 9%. That cycle dramatically repriced bonds, cooled the housing market, and forced investors to reassess the valuations of high-growth stocks.
A single word or phrase in an FOMC statement — 'patient,' 'data-dependent,' 'restrictive for longer' — can move global markets by billions of dollars in seconds, illustrating just how central this single rate has become to modern finance.