Federal Funds Rate and its Relationship to Long Term Treasuries

September 27, 2018

The Federal Reserve raised its benchmark interest rate (the Federal Funds Rate) by 25 basis points yesterday for the third time this year. The rate is now at its highest level since April of 2008.

The primary reason for the recent increase is to hedge against a potential inflation above the Fed’s 2.0% target inflation rate. The current U.S. unemployment rate is very low, and the Federal Reserve is concerned that the strength of the economy could stoke inflation. According to a 9/26/2018 article on Yahoo Finance by Myles Udland, “… the labor market is currently stronger than what the Fed thinks will be required to sustain 2% inflation and the Fed expects this trend to continue for years.”

While short-term interest rates have steadily climbed throughout the year, the 10-year treasury closed today at 3.05%. This rate is at the high end of the “benchmark’s” 12-month range but has not moved significantly.

The “benchmark” 10-year treasury also moves based on expectations of future inflation. As the Federal Reserve works to fight inflation by raising short-term interest rates, the probability of long-term inflation diminishes. The Fed’s efforts have worked by keeping long-term rates in check.