If a ship crossing a wide and placid harbor yaws so far that it almost hits the channel markers, its captain might want to have its rudder adjusted. That’s what the Federal Reserve is considering as the fed funds rate threatens to slip outside the central bank’s target range. The gap between the rate and the Fed’s upper bound has narrowed to a 7-1/2 year low, setting off alarm bells from Washington to Wall Street. It’s also prompted policy makers to discuss whether shifting tides in short-term markets mean they need to change the way they go about manipulating what is arguably the most important interest rate in the world.
In December 2015, the Fed responded to improving economic conditions by raising interest rates that it had cut to near zero during the financial crisis. It set a target range for the fed funds rate of 0.25 percent to 0.5 percent. Since then it’s increased the range five times, to 1.50 percent to 1.75 percent currently, and is on the cusp of doing so again Wednesday. For most of that time, the effective fed funds rate -- the average of what borrowers in the market actually paid -- rested comfortably near the range’s midpoint, just like it’s supposed to. But since the beginning of the year, fed funds has been creeping higher, now sitting just five basis points below the top of the range at 1.70 percent.