What is the Federal Reserve

The Federal Reserve, the US central bank, is responsible for monetary policy and interest rate regulation. Consequently, Fed decisions interact closely with major fundamental price drivers in the US and beyond. Read on for more on what the Fed is, how it operates, and the way it influences markets.

What is the Federal Reserve?
When was the Federal Reserve created?
How many Federal Reserve banks are there?
Who owns the Federal Reserve bank?
How does the Federal Reserve run?
Upcoming Federal Reserve meetings in 2021
What does the Federal Reserve do?
How does the Fed affect the money supply?
How may Fed announcements impact financial markets?
How may the Fed affect forex?
How may the Fed affect commodities?
How may the Fed affect stocks?

What is the Federal Reserve?

The Federal Reserve is the central bank of the United States and serves to maintain and grow a stable economy via price stability, regulated interest rates and maximum employment through increased demand for investment. The Fed regulates monetary policy and controls the money supply, with its measures impacting inflation, consumer behavior and various financial instruments.

When was the Federal Reserve created?

The Federal Reserve was created on 23 December 1913 by the United States Congress, with the express intention to deliver a safer, more stable and more flexible financial and monetary system to America.

How many Federal Reserve banks are there?

There is a total of 12 Federal Reserve Banks, which each operate within a district of the US. These branches serve to oversee regional economic interests, carrying out policies set by Washington by the Fed’s board of governors. Here are the 12 Federal Reserve Banks.

Boston	Atlanta	New York	Philadelphia
Cleveland	Richmond	Chicago	St Louis
Minneapolis	Dallas	Kansas City	San Francisco

Who owns the Federal Reserve bank?

The Federal Reserve Bank is owned by both public and private means. While the Board of Governors is a government agency, the banks themselves exist within a private corporation structure, with member banks holding stock and earning dividends.

How does the Federal Reserve run?

The Federal Reserve is governed by the Federal Reserve Board and is represented by a regionally-distributed assortment of Federal Reserve banks, whose duties include being depositories for bank reserves, lending to other banks, issuing banknotes as circulating currency and administering deposit accounts of the federal government.

Policy decisions are made through the Federal Open Market Committee (FOMC), an organization consisting of 12 members, chaired by Jerome Powell and made up of the Board of Governors and a few of the presidents of the Reserve Banks.

Upcoming Federal Reserve meetings in 2021

2021 FOMC meetings

26-27 January

16-17 March

27-28 April

15-16 June

27-28 July

21-22 September

2-3 November

14-15 December

What does the Federal Reserve do?

The Federal Reserve makes monetary policy decisions and oversees functional economic development through the FOMC, which holds eight scheduled meetings per year in which economic and financial conditions are reviewed. At the meetings the FOMC sets targets for the Federal Funds Rate, or the interest rate that banks offer each other for overnight loans, considering the performance of various economic indicators, such as the Consumer Price Index and GDP.

The FOMC controls the rate by buying and selling government bonds on the open market (known as ‘open market operations. Buying bonds serves to put money into the economy with the goal of lowering interest rates, while selling bonds lowers monetary supply with the goal of raising interest rates.

The FOMC also monitors the discount rate, or the rate that banks pay to borrow money from the Fed. When this rate is lower, it is also more likely the Federal Funds Rate will be lower too.

How may the Fed affect the money supply?

The Fed affects the money supply through its management of reserve requirements, which represent the levels of cash that banks must hold relative to customer deposits. The Fed raising banks’ reserve requirements restricts them from lending, lowering the money circulating in the economy. Conversely, lowering the reserve requirements enables banks to loan more, boosting the supply of money in the economy.

How may Fed announcements impact financial markets?

Fed announcements can have a significant impact on financial markets, particularly when Fed announcements reveal imminent changes to the Federal Funds Rate. Here’s how Fed decisions can affect price action from stock indices through to foreign exchange.

How may the Fed affect forex?

The Fed can affect forex through changes to the Federal Funds Rate. US rate hikes can mean international investors are attracted by higher yields on bonds. A resulting rise in USD-denominated investments can boost the value of USD against other currencies.

On the other hand, when the Fed lowers the Federal Funds Rate and interest rates fall, initial demand for bonds – in an environment of otherwise low returns – raises their price and pushes down yields. In turn, speculators may shy away from USD-denominated investments, weakening USD against other currencies.

How may the Fed affect commodities?

The Fed can affect commodities insofar as moves to change interest rates can impact the costs of holding inventory. When interest rates move higher, the price of commodities tends to decline as it costs more to finance stockpiles, disincentivizing supply and changing patterns of demand. Lower interest rates, conversely, may mean higher commodity prices as costs of stockpiling decrease and demand rises as supply becomes more consistent.

Also, Fed rate hikes in turn impacting USD can be consequential for commodities. A rising dollar caused by hikes can put pressure on US commodity exports as US goods will be more expensive to buy outside of the country. Naturally, the opposite is also true: a weakened dollar as a result of interest rate cuts will make US goods more attractive to buy from abroad.

How may the Fed affect stocks?

Fed announcements may have an impact on stocks when the Federal Funds Rate is raised or lowered. In a climate of higher interest rates, it is more expensive for businesses to service their debt, whereas lower interest rates may encourage businesses to take on more debt as it is cheaper.

Therefore, when interest rates are low, some businesses may take advantage of the resulting cheap debt to invest in growth, which may in turn inspire bullish activity across certain stocks. Conversely, higher interest rates may stifle business investment plans and prompt market speculators to move away from stocks in favor of other securities.

However, interest rate hikes can mean financial organizations such as banks, brokerages and mortgage companies can charge more for lending and perform better than other sectors that need to service debt rather than provide it.

While sometimes major US stock indices such as the S&P 500 initially react bullish to rate cuts, such as after the cut on 3 March 2020 in response to coronavirus risk, other times the news may be overshadowed by more gloomy fundamentals. For example, after Powell predicted a weak Q2 amidst another Fed cut less than two weeks later, bearish sentiment ensued.

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