The Federal Reserve is expected to raise rates on Wednesday.
This statement actually means a few different things.
When most commentators talk about the Fed “raising rates” they’re referring to an expected increase in the Effective Fed Funds rate.
Right now, this rate is around 0.13%, the middle of a 0%-0.25% range the Fed has had in place since December 2008.
(Another thing you’re likely to hear on Wednesday if the Fed raises rates is that the era of “zero interest rates” is over, though if you want to be a lot of fun at a Christmas party, tell the people around that interest rates were never at 0%. You’ll be right. Technically.)
Expectations are that this range will be increased by 0.25%, or 25 basis points, to 0.25%-0.50%.
A (somewhat) minor detail here is that the actual floor for the Fed’s current range is 0.05% because the Fed hasn’t executed any reverse repos — a transaction where the Fed swaps cash for an asset overnight for a small fee and then unwinds that trade the next day — at less than 0.05%.
The Fed’s reverse repo operations are the Fed’s primary tool for pushing rates up in the Fed Funds market.
The upper-end of this range is the interest on excess reserves, or IOER rate, and is the interest paid by the Fed to banks that park reserves with the Fed.
And so in theory the new Effective Fed Funds rate will be 0.375% or thereabouts if it continues to trade in the middle of the Fed’s corridor. But given that the Fed hasn’t raised rates under financial conditions resembling anything like what we’re looking at today there are some questions about where exactly this rate will fall.
Maybe the new Effective Fed Funds rate is closer to 0.3%. Maybe it’s closer to 0.4%. This will depend on how players in money markets react to a new Fed regime. If the Fed does raise rates on Wednesday, we’ll find out where the new Effective rate lands on Thursday afternoon when the Fed settles the first day of trading inside the new band.
But in addition to the reverse repo rate and the IOER the Fed also has a discount rate which currently sits at 0.75%. This rate is the rate at which financial institutions borrow from their regional Fed banks directly.
Economists at Goldman Sachs expect this rate will be increased to 1% on Wednesday.
As for what this means to you? The short answer is that it mostly depends on what happens to longer-term Treasury rates (think 2-year notes, 10-year notes, or 30-year bonds) mortgage rates or credit card rates could see some upward pressure in the months to come.
The Fed internal operations we’re talking about here are overnight-type operations which will ripple through financial markets, but it’s not as simple as pushing the Fed Funds rate up and sending everything else higher.
We’re loathe to write it, but time actually will tell.
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