Follow the bouncing federal funds rate (the rate member banks charge for the use of their excess reserves). That is what this market has been all about. And the rest of the short-term rates take their cue from the direction of the funds rate.

The federal Reserve supplies reserves to the banking system. From these reserves the member banks are able to create demand deposits by making loans or purchasing securities. This increase in demand deposits is reflected by an increase in the basic monetary aggregates or money supply, which is needed to carry out business transactions.

But what the Fed giveth, the Fed also taketh away. When reserves are withdrawn, the reverse effect occurs: Demand deposits are curtailed and the aggregates will decrease. Since the Fed is trying to govern the growth in the monetary aggregates, it closely regulates the amount of reserves it supplies to the banking system. maturities of similar securities, like U.S. Treasuries, you would have a yield curve. In other words, if you would plot the six-month T-bills, the year bill, the two-year note etc., up to the 30-year bond you would have a graph of the Treasury yield curve at that particular time. Up until the last two years, that curve has been positive. By going from the six-month bill to each succeeding maturity, you would be able to increase your yield.

During the past two years, the opposite has been true since we have had an inverted or negative-yield curve. The highest rates were in the shortest maturities. The idea being the aggregates will decrease. Since the Fed is trying to govern the growth in the monetary aggregates, it closely regulates the amount of reserves it supplies to the banking system.

When the Fed wants to slow down the economy, it supplies fewer reserves. The banks are forced to scramble for these reserves to create demand deposits, and this causes the gauge of the demand -- the federal funds rate -- to move higher. The greater the demands, the higher the funds rate goes.

On the other hand, when the Fed wants to stimulate the economy, it supplies more reserves so that the banks can extend credit. At the same time, since there is an abundance of reserves, the federal funds rate declines, and the rest of the short-term rates follow suit. It therefore becomes cheaper to borrow money and to do business.

When the Fed wants to slow down the economy, it supplies fewer reserves. The banks are forced to scramble for these reserves to create demand deposits, and this causes the gauge of the demand -- the federal funds rate -- to move higher. The greater the demands, the higher the funds rate goes.

On the other hand, when the Fed wants to stimulate the economy, it supplies more reserves so that the banks can extend credit. At the same time, since there is an abundance of reserves, the federal funds rate declines, and the rest of the short-term rates follow suit. It therefore becomes cheaper to borrow money and to do business.

If you were to chart at any given time the interest rates of various maturities of similar securities, like U.S. Treasuries, you would have a yield curve. In other words, if you would plot the six-month T-bills, the year bill, the two-year note etc., up to the 30-year bond you would have a graph of the Treasury yield curve at that particular time. Up until the last two years, that curve has been positive. By going from the six-month bill to each succeeding maturity, you would be able to increase your yield.

During the past two years, the opposite has been true since we have had an inverted or negative-yield curve. The highest rates were in the shortest maturities. The idea being that the higher short rates would choke off the demand for credit, slow the economy and reduce inflation.

When bond men see the fed funds rate declining as it has been (over 700 basis points since the first of the year), they see the yield curve move from being a negative to a positive curve. When short rates were much higher, investors were paid to stay in short maturities. That's one reason why the money market funds have shown such tremendous growth. But as short rates continue to fall and the curve becomes more positive, investors have a decision to make. Do they stay in short maturities that now are offering a lower yield (but greater protection of their principal) or do they move out to longer maturities to lock in higher returns (but with less protection to their principal should prices fall).