By Jen Saarbach & Kristen Kelly, Co-Founders of The Wall Street Skinny
Here’s why I don’t think this is a crazy idea…
Dallas Fed Chair Lorie Logan made headlines last week suggesting that we should abandon the Federal Funds rate as the primary mechanism for monetary policy transmission.
She’s not the first to suggest this move, nor will she likely be the last. Other pundits like Chamath Palihapitiya have been calling for this for some time now, but her remarks are notable given she will be a voting member of the FOMC in 2026.
To a casual observer, “get rid of the Fed Funds rate!” might sound revolutionary and potentially concerning. But to rates market insiders, it’s not so crazy after all.
So let’s explain.
Flash back to the pre-2008 financial markets. The Fed Funds rate, the rate at which banks lend and borrow money to and from one another overnight, was a robust market that was frequently used. Other metrics like LIBOR (the London Interbank Offered Rate) measured the rate at which banks reportedly were willing to borrow and lend to each other short term, and served as the benchmark index for calculating trillions of dollars worth of loans and derivatives every day.
But the global financial crisis reshaped the role of both.
Let’s start with the Fed Funds rate. When the Federal Reserve cut its target rate range to 0-0.25% and implemented quantitative easing, the Fed Funds market changed dramatically. Flush with cash, banks took their dollars out of the Fed Funds market and parked them directly at the Fed. As a result, the Fed Funds rate doesn’t really trade much anymore, outside of a handful of participants like the Federal Home Loan Banks.
Nearly two decades later, the Fed is in a period of quantitative tightening: allowing its balance sheet to shrink and taking cash out of the system. But the Fed Funds rate has not come back into favor.
Meanwhile, something else happened during the GFC. LIBOR proved too vulnerable to manipulation because it was not an OBSERVED rate, but rather a REPORTED rate. Banks were found to be underreporting funding stress during the Global Financial Crisis, and the decision was made to abandon LIBOR. But, what to replace it with?
The initial thinking was to replace LIBOR with the Fed Funds rate. But when you think about the spirit of making that change, the move away from LIBOR was to replace it with something that
- has actual observed trades, and
- will observably fluctuate in response to stress (or lack thereof) in the funding markets.
Since the Fed Funds rate doesn’t really trade very much anymore, it ultimately didn’t fit the bill; the total amount of borrowing/lending done at the Fed Funds rate is de minimis. Instead, the vast majority of funding trades happen in the repo markets.
“Repo” is short for “repurchase agreement”. It’s the mechanism by which banks and other market participants take out short term loans collateralized by bonds like Treasuries. Trillions and trillions of dollars change hands every day to finance levered longs and shorts.
There are so many countless recorded prints every day in the repo markets that they are theoretically immune to manipulation. They constitute a more representative gauge of what’s ACTUALLY happening than Fed Funds.
So LIBOR was officially replaced in 2023 with “SOFR”, the Secured Overnight Funding Rate, which essentially reflects the average daily repo rates.
And guess what? Repo rates, and SOFR, by extension, actually move around. The Fed Funds rate effective rate doesn’t really move much. That’s why we look at the SOFR/Fed Funds spread as an indicator of funding stress. The spread is calculated as:
Fed Funds – SOFR
So, when the spread becomes more negative, or tightens, it means SOFR is moving higher. It is an indicator that there is more stress in the funding markets.
SOFR has become the market’s canary in the coal mine. And the Fed knows this. THEY look at the repo markets constantly as well.
Here we are today. We have one set of interest rates that a) trade all day every day in massive volumes, b) actually move in response to funding stress, and c) constitute what the Fed ACTUALLY cares about!
The Fed Funds rate, by comparison, barely trades…and barely moves. So it does beg the question: why the heck are we still using this thing as the primary expression of monetary policy?
If you’re looking for an interest rate that gives you real information, the General Collateral rate, SOFR, and really anything tied to the repo markets is way more useful than Fed Funds.
I think Logan has a point. So, what would the mechanics of switching look like?
The way I think about it, Fed Funds doesn’t have to disappear. Perhaps the Fed ADDITIONALLY sets a GC or SOFR target range, and expands the role of its standing repo and reverse repo facilities in maintaining its target rate range.
And listen, fear not. Nothing is likely to happen tomorrow. The LIBOR scandal broke more than a decade before the switch to SOFR was put in place.
But Logan brings up a good point: better to initiate a switch during a time of stability than to wait for things to fall apart.