To learn more about the economy and its impact on investors, join TASBO’s webinar on October 24 featuring insights from the Texas Range team.
The Federal Reserve (the Fed) has been a focal point of reporting about inflation and the economy. By understanding the Fed’s role in the economy, Texas school finance officials can better decipher news stories and understand how the Fed influences rates on many instruments available to them.
The Fed impacts interest rates by setting a target known as the federal funds rate. This is the rate that banks charge each other for overnight loans between their accounts at the Federal Reserve. The rate is set by the Federal Open Markets Committee (FOMC).
Changes in the federal funds rate ripple through the economy. Many banks peg their lending rates for credit cards and auto loans to changes in the target rate. Longer-term loans like mortgage rates can be indirectly affected by changes in it. Bank interest rates for accounts and certificates of deposit also correlate to the target rate.
Traders in the bond market set prices for actively traded short-term fixed income securities such as U.S. Treasury bills and short-term federal agency obligations based on a variety of factors including the target federal funds rate.
Since those short-term investments comprise most of the permitted investments for local government investment pools (LGIPs), like the Texas Range Investment Program (Texas Range), net yields offered to investors are also tied to the target rate.
The Fed uses three tools to reach its target.
Open market operations are the buying and selling of U.S. Treasury and federal agency securities. The Fed buying securities from banks adds to their cash reserves, easing credit and leading to lower interest rates. The opposite occurs when it sells securities.
Discount window lending is lending to banks directly from the Fed at rates set by the board of governors. The Fed can create demand for borrowing from the discount window and charge higher rates by raising reserve requirements.
Reserve requirements dictate the level of cash that banks and other depository institutions must hold in reserve as a percentage of deposits held by their customers. When banks need cash to meet reserve requirements, rates go up. When banks don’t need cash, rates fall.
These three tools serve as levers the Fed can use to influence rates of return on many instruments available to public sector investors.
The Fed Today
At its meeting at the end of July — its most recent at the time of this article — the FOMC judged that the “risks to achieving its employment and inflation goals continue to move into better balance.”1 It observed that inflation eased but remained somewhat elevated—that, plus a strong job market, resilient economic activity, and an unemployment rate that remains low encouraged the FOMC to maintain the benchmark interest rate at a range of 5.25 - 5.5%.
The Committee does not expect it will be appropriate to reduce the target rate range until it has gained greater confidence inflation is moving closer to 2%.[1]
To learn more about the economy and its impact on investors like you, join TASBO’s webinar on October 24 featuring insights from the Texas Range team.
Texas Range offers investors two daily liquidity options, TexasDAILY and TexasDAILY Select, along with a fixed-rate, fixed-term portfolio, TexasTERM. To learn more about how Texas Range can help you achieve your school district’s cash management and investment goals, please contact Nathan Smith at 469.868.3991 / smithn@pfmam.com or Nelson Bush at 469.868.3984 / bushn@pfmam.com.