A roundup of economic news from around the Web.

Compiled by Phil Izzo

The Federal Reserve’s unprecedented switch to a range for its key target rate has propelled rate markets into uncharted territory.

The exact impact of the move to a range won’t be clear for some time. Investors and traders need to fully digest the implications of the change, and markets still need to make their way through the sticky year-end period. Nonetheless, it’s safe to say that Tuesday, Dec. 15 marked the start of a new chapter for rates markets.

“This is a different world,” said George Goncalves, chief Treasury, TIPS and agency strategist at Morgan Stanley in New York. “The Fed has moved toward the quality of money in the form of targeting specific assets. When you do that it’s a different ball game.”

The Fed Tuesday lowered its key rate from 1% to a historically-low range of 0% to 0.25% and committed to keeping it there for “some time.” It also said it will seek to support financial markets and the economy by measures that sustain the size of its balance sheet at a high level, listing a range of programs, from purchases of agency debt to mortgage-backed bonds to the possible purchases of Treasurys.

The decision, in effect, signals the end of interest rate cuts as a way to promote economic growth and points to the start of a new period in which expansion of the money supply has become the Fed’s primary tool. And a range is easier to manage, particularly as the effective fed funds rate has been trading close to zero recently.

In that sense, “a target range allows [the Fed] to accomplish basically the same policy objectives as it could under a fixed target regime,” said Kevin Giddis, managing director, head of fixed income sales, trading and research at Morgan Keegan & Co.

Overall, the Fed decision should help to suppress volatility in the front end of the curve, paving the way for more risk appetite. Lower volatility would help market participants to take advantage of market dislocations by allowing them to put on bigger trades.

“That is what helps to stabilize markets,” Goncalves said.

Treasurys rallied on the Fed’s statement and are likely to remain well-supported, particularly on the long end, as investors expect the Fed eventually to buy longer-dated securities. In addition, mortgage-related hedging needs will also support the Treasury market, as the Fed’s program to buy mortgage bonds kicks in.

The decision also lends itself to an even flatter curve. After the rate cut, Treasurys benchmark yield curve — the spread between the two- and 10-year yields — pushed to plus 161 basis points from plus 177 Monday.

For the repo market, a key secured lending market for banks and other financial institutions, the Fed move is unlikely to have a huge impact, strategists said, as rates there have already plunged to low levels. Establishing a fed funds range and implying rates will be low for a while means the general collateral rate, the rate to borrow non-specific Treasurys on an overnight basis, will stay in a low range as well. The Fed move “is a confirmation of what the GC market has been telling us,” Goncalves said.

That leaves the problems of failed trades unresolved, which some have feared could pick up again as fed funds fall toward zero as the penalty for holding onto scarce Treasurys remains minimal.

The Fed’s move should bring further relief to unsecured interbank lending markets. The London interbank offered rate has been falling since mid-October amid aggressive Fed efforts to provide liquidity to the financial system, and the key three-month Libor will likely plunge further. That’s good news for corporations and consumers, as Libor is the benchmark for adjustable-rate borrowing, including ARMs.

Eurodollar futures activity, which shows where the market expects the underlying three-month dollar Libor to settle as a result of Tuesday’s Fed action, indicated that banks are likely to significantly loosen the purse strings. March Eurodollars were pointing to an expected 1.215% yield at the contract’s March 16 expiration, down sharply from the latest cash setting from the BBA for the three-month dollar Libor, which stood at 1.8475%.

The now ultra low rates also have implications for how traders of fed-funds futures behave: they now have much less of a reason to bet or hedge against changes in interest rate expectations. Participants can still hedge on expectations for the 30-day average of the overnight effective cash funds rate though, which is the underlying index for fed-funds futures contracts.

In fed-funds futures, it’s likely “the volume of trading could drop off substantially,” said Stan Jonas, director of Axiom Management, a brokerage firm specializing in interest rates, as the Fed reduces the emphasis on the funds rate to stimulate the economy or control inflation. “No one is going to care much about fed-funds one way or the other,” the broker said.

However, the quarter percentage point range for the target means there’s still “plenty volatility,” said Peter Barker, a director of interest rate products at CME Group Inc.

For money market funds, particularly those that invest mostly in Treasurys, the low level of fed funds and the Fed’s commitment to keep rates low for an extended period could create problems.

Net yields — the returns these funds make on investments minus their expense ratios — could fall to zero or turn negative, forcing the funds to either waive fees or cut expenses to retain investors.

Recently, some money market funds that invest mostly in Treasurys have closed their doors to new investors as yields on Treasurys have fallen to historic lows. Just last week, three-month bill yields turned negative and an auction of four-week bills yielded zero.

In another move, the Fed also cut the interest it pays on reserves to 0.25 percentage point in an effort targeted at the traded fed funds market, where rates have been hovering close to zero. One reason for the low level of traded fed funds is that institutions such as mortgage giants Fannie Mae and Freddie Mac, which don’t earn interest on their reserves, have been lending these funds out in the fed funds market.

“Banks will be less inclined to absorb surplus reserves from [these] institutions, which means that some of the trading that has given the funds rate such a heavy downward bias in recent weeks may disappear,” Wrightson ICAP economists noted. –Deborah Lynn Blumberg