The rates market

It is the rate at which a central bank lends or pays interest on money overnight. It sets the base price of money in an economy: every other rate (loans, bonds, savings accounts) is built up from it.

The Fed targets a range of 25 basis points (bp) for Fed funds. It holds it with IORB, the rate it pays banks on their reserves, set 10 bp below the top of the range. The observed effective rate (EFFR) is published every morning by the New York Fed: it is the rate that futures anticipate. The ECB has three rates, of which the deposit rate has become the policy rate. The Bank of Japan targets the overnight call rate; the Bank of England sets Bank Rate.

The 10-year yield serves as a discount rate: the higher it goes, the less the distant profits of a growth company are worth today. The real rate (the yield on TIPS, which are indexed to inflation) is the true competitor of equities: when it rises, risk-free money earns more.

The 2-year, for its part, reflects what the market expects from the central bank over the next two years. It is the maturity that moves the most on FOMC days and on inflation releases.

The curve links Treasury yields from 1 month to 30 years. In normal times it slopes upward: lending for longer pays more. The 10-year minus 2-year slope sums up its shape. When it is negative, the curve is “inverted”: the market expects rate cuts, historically a sign of a slowdown, with a highly variable lag. The term premium is the extra yield demanded for tying up money for a long time; it rises with deficits and with doubts about inflation.

Four times a year (March, June, September, December), each FOMC member states the rate they consider appropriate at the end of each year and in the longer run. Each dot is an opinion, rounded to the nearest eighth of a point.

The median gives the path; the dispersion gives the disagreement; the “longer run” approximates the neutral rate, the one that neither stimulates nor restrains. It is not a promise: the dots move from one meeting to the next, and the market compares them with its own path.

30-day Fed funds futures are quoted at 100 minus the expected average EFFR over one month. A contract at 95.835 therefore expects 4.165% on average that month. By comparing the month after a meeting with the month before it, one derives the rate expected after the decision; the difference divided by 25 bp gives an approximate probability of a move. This is what tools such as FedWatch do. Prediction markets (Polymarket) give a direct reading, in dollars wagered. Both are expectations, not decisions.

FOMC: statement at 2 p.m. New York time (the rail shows Paris time), projections the same day for the marked meetings, press conference 30 minutes later. The market reacts to three things: the decision, the words that change in the statement, and the tone of the press conference. ECB: decision at 2:15 p.m. Frankfurt time, press conference at 2:45 p.m. BoE: noon in London, with the vote of the nine members. BoJ: during the morning in Tokyo, often before the European open; its hikes weigh on the yen and on the carry trade (borrowing in yen to invest in dollars), whose abrupt unwinding shows up on the Nasdaq.

bp: basis point, one hundredth of a percentage point. EFFR: effective federal funds rate. SOFR: overnight rate secured by Treasuries, the benchmark for dollar loans. €STR: its euro equivalent. SONIA: the same for the United Kingdom. TIPS: inflation-indexed Treasuries. Breakeven inflation: nominal yield minus real yield, the average inflation the market expects. SEP: the FOMC's Summary of Economic Projections, which includes the dot plot. MPM: the BoJ's Monetary Policy Meeting. MPC: the BoE's Monetary Policy Committee.