Implied from Fed Funds Options*:
Felix Salmon, William Polley, David Gaffen and Nouriel Roubini began a discussion last month, now continued at Greg Mankiw's blog, about whether the Fed has already cut the Fed Funds rate target without announcing it. The evidence for an implicit cut is that the Effective Fed Funds rate has averaged only 4.97% since August 10 (data here), versus an official target of 5.25%:
The innocent explanation for this, which most people except Roubini seem to be accepting, is that the increased volatility in the fed funds market has made it harder for the Fed to hit its target, so they're simply erring on the side of caution.
I don't think that's what's happening for two reasons.
First, there have been other periods of volatility in the fed funds market that didn't produce significant under- or over-shooting of the target rate. The picture below shows the scatterplot of absolute deviations of the daily effective fed funds rate from the target versus the intraday fed funds range (high minus low) since July 2000. I've removed the Sept 11, 2001 outliers, though it doesn't change much if you leave them in. The data since Aug 10th is bolded, and the straight line is the regression using pre-Aug 10 data.
The Fed's undershooting clearly is not purely a result of higher intraday volatility.
Second, the Fed can intervene in the fed funds market as often as it wishes. Typically it only does so once a day in the morning, but it can and occasionally has conducted open market operations more frequently intraday. So if the Fed really wanted to hit a 5.25% target, it could.
The conclusion I'm forced to make is that the Fed is hitting its target, but that target is 5%.
