Fed Funds Rate

Target interest rate set by the U.S. Federal Reserve for overnight bank lending.

The Federal Funds Rate is the target interest rate set by the Federal Open Market Committee (FOMC) at which commercial banks borrow and lend their excess reserves to one another overnight. Although it is technically a rate for interbank lending, it serves as the primary benchmark for the entire U.S. financial system. It influences virtually all other interest rates, including mortgages, credit cards, auto loans, and savings accounts. The Federal Reserve does not set the exact rate directly; instead, it establishes a target range (such as 5.00% to 5.25%) and uses monetary policy tools, like paying interest on reserve balances and conducting open market operations, to guide the actual market rate into that target range. Investors pay close attention to this rate because it is the main lever of U.S. monetary policy. When the Fed raises the rate, it increases the cost of borrowing, which is intended to cool down an overheating economy and curb inflation. Conversely, lowering the rate makes borrowing cheaper, stimulating economic activity and corporate investment. High rates generally pressure stock valuations downward as borrowing costs rise and bonds become more competitive, while low rates tend to boost equity markets.

If the Federal Reserve's target range for the Fed Funds Rate is 5.00% to 5.25%, a commercial bank with $10 million in excess reserves at the end of the day might lend those funds overnight to another bank facing a temporary reserve deficit. The lending bank charges an annualized interest rate of 5.12% on the overnight loan, which falls directly within the Fed's target range. The borrowing bank pays approximately $1,422 in interest for that single night ($10,000,000 0.0512 / 360 days).