Fed Losing Credibility?

That's what David Rosenberg of Merrill Lynch charged in a note to clients today.

The issue at hand is the continued gap between the market fed funds rate and the target rate. The market rate has traded below the target for 16 straight days, Rosenberg points out, even after fed funds was lowered to 1 percent last week.

While most analysts think this is a sign of the Fed's quantitative easing strategy (to inject funds into the economy without using interest rate policy) Rosenberg thinks the FOMC needs to just come out and say it:

If the Fed has decided that they will no longer concern themselves with a Fed funds target they should admit as much in order to retain their credibility, in our view. Alternatively, if they still wish to target a Fed funds rate we think they should either lower it to market rates or act more aggressively to push the effective rate up to the announced 1% target rate. Having a target which they are unable to meet hurts the Fed's credibility at a time when markets are expecting another 50% increase in their balance sheet by year-end.

And it looks like the Fed was thinking along similar lines. This morning it announced that it would increase the interest paid on reserves to match the target federal funds rate. Wrightson-ICAP thinks this will "boost the effective funds rate by an extra couple of basis points."

My question: Paying interest on reserves is supposed to put a floor on the market fund rate and before today, the rate paid on reserves was basically 10 basis points less than the target. So why did the market rate trade even below that level?