Calm Is Returning to Fed Funds Market

After a hectic winter and an average spring, the fed funds market appears to be headed for the summer doldrums.

Economists and fed funds traders say low volatility should continue for the next several months.

"It's going to be more dullsville," said one fed funds broker.

The effective fed funds rate for the two weeks ended last Wednesday was 5.76% - right on top of the 5.75% target rate apparently set by the Federal Reserve.

Fed |Just Watching'

"The Fed's finished really easing on a regular basis," said one fed funds trader at a money-center bank. "Now, they're just watching."

For the past several weeks the weekly effective rates, which tend to fluctuate more than the two-week averages, have been within 4 basis points of the target rate - a very narrow range.

A more stable fed funds market would be good news for bankers. It would mean not having to worry so much about their overnight funding costs.

Rapid changes in the fed funds rate, the rate banks charge each other when they trade excess reserves overnight, can make it expensive for banks to meet their reserve requirements. They run the risk of having to buy fed funds when the rate is extremely high in order to obtain the reserves the Fed says they must have.

Wild Swings in Winter

The fed funds rate was extremely volatile this winter - as low as 0.125% and as high as 100% on occasion. Seasonal factors accounted for part of the volatility, because banks often trade large amounts of fed funds close to the end of the year to make cosmetic changes to their balance sheets.

But the rate also moved around because the Fed was trying to lower interest rates by reducing its apparent target for the fed funds rate. Changes in the Fed's target rate typically generate some excitement in the market.

Rate swings resulted as well from the Fed's move to cut reserve requirements for banks late last year. The move reduced the amount of reserves banks needed to keep on hand, making them more liquid, but it also meant the central bank had to fine-tune its approach to handling reserve requirements for the banking system as a whole.

Adjusting to New Rules

Dramatic rate shifts followed as the Fed and the banks tried to manage their positions according to the new rules.

Now, though, after several months, the Fed is better able to manage the supply of reserves in the overall system under the new requirements. In addition, the rapid-fire cuts in the target fed funds rate appear to have stopped, at least for now.

As a result, the fed funds rate has been extremely stable for the past few weeks.

"The Fed's been on hold for a little while," said Jan Hurley, senior market analyst at Chase Manhattan Corp. "On a day-to-day basis, the volatility has really come in. I think it will stay that way for a while."

Volatility will likely remain low until sentiment builds that another rate cut is imminent, Ms. Hurley said. And even then, wild rate swings are not likely to resume.

"In a few months, if economic data do not indicate imminent recovery, people might start looking for another ease. But in no way am I expecting us to return to the volatility levels of January and February," said Ms. Hurley.

PHOTO : Fed Funds Rate Settles Down

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