Is this the same as the OIS rate? Whether the Federal Reserve wants to buy or sell bonds depends on the state of the economy.
It represents the cost of repeated overnight unsecured lending over periods of up to two weeks sometimes more. Because it is based on overnight lending, it is assumed to have a lower credit risk than longer term interbank loans based on say 1M, 2M or 3M Libor and this is what drivers the OIS-Libor spread. An overnight index swap OIS is a swap in which one party pays a fixed rate of interest known as the OIS rate which depends on the term of the swap and is known at trade inception.
It is linked to the cost of unsecured lending. The other party pays the rate equivalent to the daily compounded index rate over the life time of the OIS. This is not known until the end of the life of the OIS. To make the OIS swap have zero initial value at inception, which is how it is traded, the OIS rate therefore must equal the market's expectation of what the compounded daily geometric average index rate will be over the lifetime of the OIS.
In USD the index rate is the fed funds rate which is linked to the cost of unsecured lending. The main use of OIS swaps is to allow banks to lock in the cost of unsecured overnight funding in advance. Finally, your confusion may be due to the use of OIS for discounting of collateralised non-cleared derivatives. This is market practice since The OIS rate is used because it is close to the typical interest rate paid on the collateral that is held. It becomes the best estimate of the risk-neutral risk-free rate in a world where the collateral has effectively eliminated counterparty risk.
Secured and unsecured refers to lending. It is a different animal. For example my name is Noob Rademayer, I am not a bank so I can't lend or borrow FF in the interbank market, but I can bet on the rate at which banks do.
For example I could bet that the cost of borrowing 1,, in FF over the next 30 days will go up. As previously stated, this rate influences the effective federal funds rate through open market operations or by buying and selling of government bonds government debt.
Similarly, the Federal Reserve can increase liquidity by buying government bonds, decreasing the federal funds rate because banks have excess liquidity for trade. Whether the Federal Reserve wants to buy or sell bonds depends on the state of the economy. If the FOMC believes the economy is growing too fast and inflation pressures are inconsistent with the dual mandate of the Federal Reserve, the Committee may set a higher federal funds rate target to temper economic activity.
In the opposing scenario, the FOMC may set a lower federal funds rate target to spur greater economic activity. Therefore, the FOMC must observe the current state of the economy to determine the best course of monetary policy that will maximize economic growth while adhering to the dual mandate set forth by Congress.
In making its monetary policy decisions, the FOMC considers a wealth of economic data, such as: The federal funds rate is the central interest rate in the U. It influences other interest rates such as the prime rate, which is the rate banks charge their customers with higher credit ratings. Additionally, the federal funds rate indirectly influences longer- term interest rates such as mortgages, loans, and savings, all of which are very important to consumer wealth and confidence.
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