Fed Hikes Interest Rates Once More — Freight Costs May Be Headed Up

Freight companies are feeling the pressure from another rate hike by the Federal Reserve. The central bank increased its target for the federal funds rate on September 16, lifting it by 25 basis points to 3.75%–4.00%. This marks the first such move following a series of reductions. Fed Chair Kevin Warsh described inflation as “too high and has been for too long.”

Beginning with September 17, the Federal Reserve raised every one of its administered rates by the same amount. IORB went up from 3.65% to 3.90%. The ON RRP rate followed suit, going from 3.50% to 3.75%. Primary credit (discount) and the SRF both now sit at 4.00%.

This industry depends on financed equipment, revolving credit, and consumer demand for the goods it hauls — a chain worth examining from start to finish.

The Dual Mandate and the FOMC

Congress gives the Fed two goals: keeping prices stable and reaching the highest level of employment that can be sustained. Eight meetings a year bring together the Federal Open Market Committee, which includes seven Governors along with five of the twelve regional Reserve Bank presidents serving on a rotating basis. At those gatherings, they set the target range for the federal funds rate — the rate at which banks lend their reserve balances to each other overnight.

When inflation, as measured by the Personal Consumption Expenditures Price Index (PCE), the Fed’s preferred gauge, runs above the 2% target while labor markets stay resilient, the dual mandate tilts toward price stability, even at the cost of some growth.

How One Target Range Becomes a Traded Rate

The Federal Open Market Committee doesn’t set the federal funds rate itself. Instead, it establishes a target range and relies on four managed interest rates to keep the actual market rate within that range, with two of those rates applying to banks and two to non-banks.

The lowest limit for banks is IORB: because a bank can always earn 3.90% risk-free at the Federal Reserve, it will never lend to anyone else overnight for less than that. For non-banks, the lowest limit is ON RRP. Government-sponsored enterprises (GSEs), money market funds, and primary dealers — entities that cannot hold reserve accounts — get a risk-free overnight option at 3.75%, which means cash does not get lent below that rate outside the banking system.

On the ceiling side, the arrangement operates in a distinct way. Banks can borrow from the Fed at 4.00%, which prevents them from having to pay a higher rate somewhere else. Meanwhile, the SRF provides banks and primary dealers with a backup source of funds, allowing them to borrow against Treasuries and agency debt at 4.00% when repo markets tighten. This backstop is designed to prevent the kind of bank run depicted in It’s a Wonderful Life.

The Number That Actually Matters Day to Day

What truly counts on a daily basis is the effective federal funds rate, or EFFR. That figure comes from the New York Fed and represents the volume-weighted median rate at which banks actually trade with one another. It does not get set directly; instead, it surfaces from the give-and-take of supply and demand within the corridor.

The EFFR usually trades close to IORB but sits a few basis points below it. Not all active lenders qualify for IORB. The FHLBs, in particular, are large habitual fed funds lenders who cannot earn IORB themselves, so they lend below it instead of sitting idle.

The final full day before this week’s hike saw EFFR print at 3.63%, with an IORB of 3.65% and a target range of 3.50%–3.75%, matching that familiar dynamic exactly. ON RRP was put in place to stop that kind of leakage from turning into a full-scale leak: without a risk-free floor available to non-banks, FHLB lending could drive rates all the way down through the bottom of the range.

Post-hike, expect EFFR to resettle just under the new 3.90% IORB and comfortably above the new 3.75% ON RRP floor.

Interest as the Price of Time

The various rates examined here are practical expressions of a single idea: economic interest, the return that savers receive when they set money aside for others’ use, and the cost that borrowers pay to use that money instead. In essence, an interest rate represents the price of time preference, or what a person asks for giving up immediate control over their own funds for a given span of time.

The market for loanable funds (LF) sets this price on its own, with the supply of savings meeting the demand for borrowing used to fund investment and consumption, clearing at an equilibrium rate just like every other price in the economy. The supply and demand for LF follow the same logic:

• When the interest rate goes up, people borrow less (quantity demanded falls).
• More people free up money to invest (quantity supplied rises).
• The opposite happens when the rate goes down.

The Federal Reserve does not eliminate the market entirely. Instead, it overrides the price at the short end by making risk-free returns artificially available at whatever level it chooses through IORB and ON RRP. Since the whole term structure of credit — Treasury yields, mortgage rates, commercial paper, revolving credit lines — prices off that short-term risk-free rate, moving it ripples through every borrowing decision in the economy.

Why Raising Rates Cools Inflation

Banks raise their loan rates when policy rates go up, because the cost of funds rises for them first, and they pass it along. That makes borrowing more expensive for consumers and investors alike. The result is that the threshold cost of taking on debt rises across the board, slowing both spending and investment.

A slower pace of credit expansion alongside a steady near-term supply of goods and services helps keep prices from rising too quickly. When U.S. interest rates go up, they attract foreign money looking for that safe return, which makes the dollar stronger and cheaper to buy imports.

What Freight Companies Face Now

The carriers depend on financed vehicles and open lines of credit. Now, the cost to borrow has risen for all of it, while the shrinking supply of available credit leaves less money pursuing the same volume of goods.

A strong dollar reduces the cost of foreign goods brought into the country, which cuts what consumers pay for them. That same strength, though, holds back the shipping work that brings those goods here. The stronger dollar also pushes down the price of American goods overseas.

The process behind the Fed’s action is complicated, yet the result is plain to see: rates have gone up. Freight carriers depend on the narrow space between these costs, where their profits sit.

Source material: “The Fed Just Raised Rates Again: Here’s What It Means for Freight,” Yahoo Finance.

borrowing costs · economy · Fed · freight · interest rates