From Art Cashin's notes: "Beating A Dead Horse – Redux – While Wall Street and the financial media are consumed with "when" the Fed will hike rates, there continues to be little to no discussion of the mechanics of the rate move. It's worth time to look at the process.
When the Fed begins to move rates, the vehicle they will use is the Fed Funds rate. Fed Funds are reserves lent by one bank to another to keep the borrowing bank in compliance with Federal Reserve "reserve requirements." In the old days, like back when I started, the Fed would add and subtract money in the system and use the Fed Funds rate as a thermometer to tell them how light or loose money had become through their actions. This system was less than perfect since there were occasional "surprise" spikes or plunges due to unexpected circumstances.
To smooth things out the Fed switched to targeting the Fed Funds rate to hint the level of tightness and interest rates it was shooting for.
The current target for Fed Funds is officially 0 – 0.25%. In theory that means the Fed wants no bank to have to pay any higher than 0.25% to borrow excess free reserves from another bank.
But, the problem here is that there are presently about $2.7 trillion in excess free reserves in the banking system, and, to avoid any disruptive accidents, the Fed is already paying the banks 0.25% to keep those reserves at the Fed. For another bank to borrow free reserves, they would have to top the 0.25% risk free rate the Fed is currently paying. Thus, de facto, the Fed Funds rate is already 0.25% bid – offered at some higher level.
Further, to keep that $2.7 trillion from flooding the system, the Fed will have to hike its bid along with any hike in Fed Funds. So, the Fed might wind up paying 0.35% on reserves, effectively making the Fed Funds 0.35% bid – offered at some higher increment..."
at http://kingworldnews.com/gold-commodities-and-the-2-7-trillion-problem-as-mutual-fund-cash-levels-hit-an-all-time-low/
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