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Why track the Fed funds rate over the last 6 months?

Surbhi Jain

Comparing short- and long-duration ETFs over the last 6 months (Part 2 of 7)

(Continued from Part 1)

The Fed funds rate over the last six months

The Fed funds rate has been zero lower bound for the last six months. This is how the U.S. Federal Reserve intended it to be. The quantitative program has been providing enough liquidity to the markets, driving down interest rates to their lowest levels. Consequently, the Fed funds rate can be seen to have declined for most part over the last six months.

Moreover, the Fed intends to keep the Fed funds rate at its low level for some time in future, as indicated by the March FOMC Statement.

Changes in the Fed funds rate affect Treasury ETFs like the iShares Barclays 1-3 Year Treasury Bond Fund (SHY) and the iShares Barclays 20 Year Treasury Bond Fund (TLT), which track the performance of short-term and long-term U.S. Treasury securities, respectively. ETFs like the SPDR S&P 500 ETF (SPY), and the iShares S&P 100 ETF (OEF), which track broader market indices and hold the large-cap equities of companies like Apple Inc. (AAPL) and Exxon Mobil Corp. (XOM) in their portfolio, are useful in indicating the course that the U.S. economy is taking.

Future expectations with the Fed funds rate

Pursuant to the March FOMC meeting, the Fed replaced the quantitative guidance on the course of the Fed funds rate with a more qualitative guidance. The minutes of the March FOMC meeting chaired by Janet Yellen indicated that the FOMC is likely “to maintain the current target range for the Federal funds rate well past the time that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below the Committee’s 2% longer-run goal.” Until then, you can expect the Fed funds rate to stay at ZLB level.

Expectations with respect to a rise in the Fed funds rate influence investors’ decision to a great extent. As all other rates are directly (as in the case of floating rates) or indirectly based on the Fed funds rate, investors’ decisions with respect to the duration of their investment is, to quite an extent, driven by expectations with respect to changes in the Fed funds rate.

Read on to the next part of this series to see how short-duration and long-duration ETFs have reacted to changes in interest rates over the last six months.

Continue to Part 3

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