3 month Treasury bill yeild and the Fed Funds Rate.

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Forsmant Posted: Tue, Jun 3 2008 10:25 PM

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It appears as though the Fed Funds rate tries to mimic the yeild of a three month treasury bill. 

Doesn't the market set 90 day t-bill yeailds?  The are other graphs that show the fed fund rate lagging the 3 month t-bill rate.

I need some help in understanding why the fed mimics that rate, and why austrians blame the Fed for price fixing if they are just following the market for the most part.  I know it is not ecxactly the same as market rates.

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LanceH replied on Wed, Jun 4 2008 7:49 AM

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The main influence on the T-bill yield is the anticipated FFR. It would be surprising if the T-bill yield did NOT lead FFR.  I would expect the market to have a better idea of what the Fed will do than the Fed itself.

That said, the T-bill yield is not the best leading indicator of the FFR.  A better leading indicator is the FFR futures rate.  That is because there are other influences on the T-bill yield.

Foremost amongst those other influences is the Yen carry-trade, i.e. borrowing Yen at a low interest-rate to invest in US T-bills at a higher interest-rate.  This does not have the influence that it used to since USDJPY started to fall in mid 2007.

Another influence emerged during the credit crisis - the need to hold cash outside of the banking system.  T-bills met this need admirably.  The demand for T-bills was so great in March that it drove down the yield to an intraday low not seen since 1942.  In an unusual move, the Fed was forced to target the T-bill yield directly by selling vast numbers of T-bills during OMO specifically to get the yield back up.

Do Austrians blame the Fed?  No, they blame the banking system, with Fed as head and banks as members, operating as a legally privileged cartel.  The private banks suck from the Fed's teats like piglets from a distended sow.  But they operate within the law and deserve no more censure than anyone else who lives off welfare.  The fault lies in the law itself.

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fsk replied on Wed, Jun 4 2008 12:00 PM

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I wrote about this on my blog: http://fskrealityguide.blogspot.com/2008/05/yield-curve.html A natural arbitrage process guarantees that the 3 month Treasury yield is approximately equal to the expected Fed Funds Rate over the next 3 months. Otherwise, you could make a profit buying one and shorting the other.

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Anonymous Coward replied on Wed, Jun 4 2008 12:06 PM

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I've heard that the Fed funds rate minus the 3 month T-bill (or the other way around, I'd have to look it up) equals the inflation adjusted interest rate.

A bit more trivia...

If the above indicator and the Austrian Money Supply both dip into the negative this has successfully predicted the last 8 or so recessions, including the current one. Both separately have had a miss or two but together they have been spot on.

Interestingly enough if you add in the sweeps estimates from the Fed this relationship goes away.

I lost the link so if anyone has it I would appreciate if you could post it.