What it is
The federal funds rate is the interest rate at which US depository institutions lend reserve balances to each other overnight. The Federal Open Market Committee sets a target range for it, and because it anchors the shortest end of the yield curve it is the reference point for almost every other dollar interest rate.
How it works
The rate actually observed, the effective federal funds rate, is a volume-weighted median of real transactions. The Federal Reserve keeps it inside the target range using administered rates: interest on reserve balances paid to banks and an overnight reverse repurchase facility available to a wider set of counterparties, which together act as a soft ceiling and floor. The FOMC meets eight times a year and publishes a statement, economic projections and, quarterly, the dot plot of participants' rate expectations.
How traders use it
For traders the decision itself is rarely the event, because futures markets price the expected path continuously. What moves assets is the change in that expected path implied by the statement, the projections and the press conference. The rate feeds directly into discount rates, carry trades, currency interest differentials and the funding cost of leverage.
Where it breaks down
Two cautions are worth carrying. Probabilities implied by fed funds futures are widely quoted as if they were clean forecasts, but they contain risk premia and depend on assumptions about the timing of moves within a month. And forward guidance is a statement of expectation, not a commitment: the projections are conditional and have been revised substantially inside a single year. Policy also acts with long and variable lags, so today's rate is not the condition the economy is currently experiencing.
Educational reference. This entry describes how a concept is defined and used. It is not investment advice, not a recommendation, and not a signal. Any rule you build from it should be tested with realistic costs before it is traded, and no historical result guarantees a future one.