SOFR vs. Fed Funds: Key Differences and How They Impact Markets

Interest rates play a key role in financial markets, influencing borrowing costs and investment decisions. Two important benchmarks in the U.S. are the Secured Overnight Financing Rate (SOFR) and the Federal Funds Rate (Fed Funds). While both measure short-term borrowing conditions, they differ in how they are determined and applied.

Calculation

SOFR is based on transactions in the U.S. Treasury repurchase agreement (repo) market, where financial institutions borrow cash overnight using Treasury securities as collateral. The rate is calculated as a volume-weighted median, representing the midpoint of transaction rates when arranged by size. This method prevents extreme values from distorting the benchmark.

The Federal Funds Rate, by contrast, is based on unsecured overnight lending between banks. It represents the rate at which depository institutions lend excess reserves to one another. Unlike SOFR, which is purely market-driven, the Fed Funds Rate is influenced by the Federal Reserve’s target range and monetary policy actions. The effective rate is calculated as a volume-weighted average of reported transactions.

Data Sources

SOFR is derived from transaction-level data collected by the Federal Reserve Bank of New York from the U.S. Treasury repo market. These transactions involve banks, asset managers, and other financial institutions using Treasury securities as collateral. The data comes from platforms such as the Depository Trust & Clearing Corporation (DTCC) and the Bank of New York Mellon’s tri-party repo system.

The Federal Funds Rate is based on data reported by depository institutions engaged in unsecured overnight lending. The Federal Reserve compiles this information from the Fedwire Funds Service and other reporting institutions. Because these loans lack collateral, the rates can be affected by factors such as a bank’s creditworthiness and liquidity conditions. The Federal Reserve Bank of New York publishes the Effective Federal Funds Rate (EFFR) based on a weighted average of these transactions.

Administration

The Federal Reserve Bank of New York oversees SOFR, ensuring its accuracy as a benchmark rate. It publishes daily transaction volumes and rate calculations. The Alternative Reference Rates Committee (ARRC), convened by the Federal Reserve, supports the transition to SOFR as the replacement for LIBOR, offering guidance on contract language and best practices.

The Federal Open Market Committee (FOMC) sets the target range for the Federal Funds Rate, influencing short-term borrowing costs. The Federal Reserve manages liquidity in the banking system through open market operations, interest on reserve balances, and the overnight reverse repurchase agreement facility. These tools help keep the Effective Federal Funds Rate within the target range.

Publication Frequency

SOFR is published each business day by the Federal Reserve Bank of New York at approximately 8:00 a.m. Eastern Time, reflecting transactions from the previous day. If errors exceeding a certain threshold are identified, the rate may be revised and republished later that day, though this is rare.

The Effective Federal Funds Rate follows a similar daily schedule, with the Federal Reserve Bank of New York releasing the rate at around 9:00 a.m. Eastern Time. Unlike SOFR, which is based on a broad set of market transactions, the Fed Funds Rate is influenced by Federal Reserve policy and liquidity conditions, making its daily movements a key indicator of monetary policy implementation.