After fully pricing in a 25 bps rate hike by the January FOMC meeting midday Friday after the better than expected jobs data, the February fed funds contract is backing off and now pricing in a 76% chance of a hike. There are a few levers the Fed will undertake before they start raising the fed funds rate when the time comes, and it will begin with halting their QE policy for both MBS and Treasuries. The other weapon they may utilize is to raise the interest rate paid on bank reserves held at the Fed in order to dissuade banks from using their excess reserves to lend too much. While these are the initial steps the Fed will exercise IF the inflation picture turns for the worse, nothing will be more symbolic than moving the fed funds rate off flat line.
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