Money Market Returns Feel Sting of Fed Cuts

Chart of the Week for June 27-July 3, 2003

The Federal Open Market Committee (FOMC), currently chaired by Alan Greenspan, met Tuesday and Wednesday to discuss the economy and the level of money supply. During this meeting, the FOMC members decide where they should target the fed funds rate. On Wednesday they announced their decision to cut the Fed funds target rate by 0.25%. The fed funds target rate is the rate that banks use to lend money to each other on an overnight basis. This is one of the tools the Federal Reserve uses to control monetary policy. Decreasing the fed funds target rate is viewed as expansionary and an attempt to stimulate the economy, while increasing the fed funds target rate is viewed as contractionary and an attempt to slow the economy.

Money market fund rates are compared to the fed funds target rate because they are also short-term in nature. They can invest in instruments with a term to maturity of 13 months or less and the fund as a whole must have an average maturity of 90 days or less. As the chart shows, money market fund rates have been declining since 2001 (rates shown reflect fees charged by the funds). We can expect money market fund rates to increase once the FOMC begins to raise the fed funds target rate.

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