What the Fed is and how it affects the markets

27 February 2024

The Federal Reserve System (Fed) is the central bank of the United States of America. It is responsible for managing the country's monetary policy, regulating the banking system and ensuring the stability of the financial system. The main body of the Fed is the Federal Reserve Board, which consists of seven members appointed by the President of the United States and confirmed by the Senate. The Fed also has 12 regional Federal Reserve Banks distributed throughout the country.

History of the Fed

The Federal Reserve System (Fed) was created in 1913 as a result of the Federal Reserve Act. The law was passed in response to a series of financial crises that occurred in the United States in the late 19th and early 20th centuries.

Prior to the creation of the Fed, the United States did not have a central bank. The country's banking system was decentralized, and this made it difficult to control the money supply and credit. As a result, this led to financial crises where banks went broke and depositors lost their money. Before the creation of the Fed, the United States had tried to create a centralized governing body, but each time the result was failure.

The Federal Reserve Act created a system of 12 regional reserve banks located throughout the country. These banks are private corporations, but they are controlled by the Board of Governors of the Fed, which is an independent federal agency.

Let's look more closely at the reasons for the creation of the Fed:

  • A decentralized banking system could not effectively regulate the money supply and credit.
  • Financial crises in the late 19th and early 20th centuries showed the need for a central bank. Between 1873 and 1907, the United States experienced several major financial crises that resulted in loss of deposits and bank failures. These crises showed that a decentralized banking system could not provide stability to the financial system.
  • The Fed needed to be independent of the government so that it could make decisions independent of political considerations. The Fed was designed as an institution that could respond effectively to changes in the economy and regulate the money supply to ensure financial stability.

Independence of the Fed

As mentioned earlier, the Fed was created as an organization independent of the government so that it could make decisions independent of political considerations. This was done so that the Fed could focus on its core functions, such as regulating the money supply and credit conditions, and not succumb to political pressures. The Fed's independence is one of its key features, and it has been a point of contention throughout its history. Some people believe that the Fed is too independent and that it should not be unaccountable to the government. Others believe that the Fed's independence is necessary to ensure the stability of the financial system. However, in reality, the Fed acts in any case for the purposes of the United States, and the top institutions are closely related to each other, so these disputes are useless. The Fed has played an important role in the development of the American economy. It helped to stabilize the financial system and ensure economic growth.

Let's look at the positive impact of the Fed with a real-life example:

The Great Depression was one of the most serious economic crises in U.S. history. It began in 1929 with a stock market crash and led to a sharp decline in production and employment. By 1933, the US economy had halved and unemployment had reached 25%. The Fed played an important role in preventing a complete collapse of the financial system during the Great Depression. It provided loans to banks that were on the verge of bankruptcy and helped stabilize the stock market. In 1932, the Fed provided loans to Charles Sherman Bank, which was on the verge of bankruptcy. This prevented the bank from going bankrupt and possible difficulties for other banks.

The Fed also used its monetary policy to stimulate economic growth. It lowered interest rates to make credit more affordable for businesses and consumers. This helped stimulate investment and consumption, which led to a gradual economic recovery. In addition, in 1933, the Fed opened up an open market system that allowed it to buy and sell government bonds. This allowed the Fed to increase the money supply and lower interest rates. The next step the Fed took during the Great Depression was to create a deposit insurance system in 1934. It protected depositors from losing their money if a bank went bankrupt. It helped restore confidence in the banking system. However, some critics believe that the Fed did not do enough to prevent the Great Depression. They argue that the institution should have lowered interest rates earlier and more to stimulate the economy. Other critics believe that the Fed did too much to save banks that did not deserve to be saved. They argue that it helped preserve an inefficient banking system that eventually led to another crisis in 1929. Overall, the Fed's policies during the Great Depression are considered more successful than not. It helped prevent a complete collapse of the financial system and stimulate economic growth. Some economists also believe that the Fed played a role in creating the mortgage crisis of 2008 because it encouraged the growth of subprime lending. However, in retrospect, the Fed's behavior has had more positive effects on the U.S. economy. Throughout the institution's history, it has helped ensure the stability of the financial system, stimulate economic growth, and control inflation.

Who runs the Fed

The Fed is an independent organization, but it reports to the U.S. Congress. The Fed is governed by the Board of Governors, which consists of 7 members, including the chairman and her deputy. The members of the Board of Governors are appointed by the US President and confirmed by the Senate. The Chairman of the Fed is the head of the Board of Governors and is responsible for implementing Fed policy. The Chairman is appointed by the President of the United States and confirmed by the Senate for a term of 4 to 14 years. The Vice Chairman of the Fed is the second highest ranking official at the Fed and assists the Chairman in implementing the country's monetary policy. The Vice Chairman is also appointed by the President of the U.S. and confirmed by the Senate for a term of 4 to 14 years. The other 5 members of the Board of Governors are appointed by the President of the U.S. and confirmed by the Senate for a term of 14 to 18 years. The members of the Board of Governors must have a background in banking, finance or economics. To elaborate, the selection process is as follows:

  • The President of the United States draws up a list of candidates for the Board of Governors.
  • The list of nominees is submitted to the Senate for approval.
  • The Senate holds hearings on the nominees and votes to confirm them.

Some critics believe that the process of selecting members of the Board of Governors is too politicized. They argue that the U.S. president often appoints people to these positions who share his political views. Other critics believe that the selection process is not transparent enough. They argue that the public is not always given enough information about the candidates. Nevertheless, in general, the selection process for Governing Board members is considered to be effective. It strikes a balance between the Fed's political and economic independence. The Fed is currently led by Jerome Powell, who was reappointed for a second term on May 12, 2022.

What is the Federal Reserve Central Bank (The Fed)?

Powell has been chairman of the Federal Reserve Board since February 5, 2018. He was nominated by President Donald Trump and confirmed by the Senate. Powell is the former head of Goldman Sachs. He holds a bachelor's degree in economics from Princeton University and a master's degree in business administration from Harvard Business School. The Fed's vice chair is Lael Brainard, who was nominated by President Joe Biden and confirmed by the Senate in December 2021. Brainard is a professor of economics at Princeton University. She holds a bachelor's degree in economics from Harvard University and a Ph.D. in economics from the University of Chicago.

The role of the U.S. Federal Reserve in the economy and global financial markets

The Federal Reserve System (Fed) is the central bank of the United States. It plays an important role in the U.S. economy because it is the institution that handles monetary policy: the Fed uses its monetary policy to stimulate economic growth and control inflation. It does this by changing interest rates and other monetary policy tools. Historically, the U.S. economy is one of the strongest and most influential economies in the world - which is why the interest rates set by the U.S. Federal Reserve affect not only local markets in the states, but also global markets. One of the Fed's main objectives in setting this rate is to ensure price stability and maintain employment levels in the U.S. Depending on the current economic situation and monetary policy goals, the Fed either raises or lowers interest rates or leaves them at the same level. Higher interest rates make borrowing more expensive, which can lead to slower economic growth. This happens because companies and consumers are less likely to take out loans when they are more expensive. Higher interest rates make loans more expensive, which leads to slower economic growth because more will have to be paid back: people, businesses, and others refrain from taking out high-interest loans, which leads to less spending. Demand is reduced, which in turn reduces the prices of goods and services. This removes liquidity from the markets, because the less credit is taken out, the less money is in circulation, so there is less opportunity, improvement and growth - all of which leads to a lower consumer price index. Lower interest rates make credit cheaper, which can lead to stimulating economic growth. In this situation, people, businesses and companies are willing to take out loans as they become cheaper. The more loans are taken out, the more money is put into circulation, which means there is more room for improvement and growth - leading to a higher consumer price index. High interest rates tend to keep inflation in check, but they can also slow economic growth and make credit more expensive. On the other hand, low interest rates help stimulate the economy but can increase the risk of inflation. The Fed's interest rate plays a key role by influencing financial markets, including forex, stock markets, bond markets and even cryptocurrencies.

Forex market:
During such periods, the dollar may be more attractive to investors. This is because investors, businesses, and other market participants tend to protect themselves by exiting risky assets, favoring conservative options to save money - which is exactly what the dollar can be. In times of recession and crises in the economy, people start selling their assets (causing the price of assets to drop). By selling assets, they are essentially buying dollars or other fiat money. Any buying and selling transaction is an exchange of a commodity/asset for money. Because people are selling assets and buying fiat, they are creating a demand for money and even a shortage of it. This works in the opposite direction as well: the more people buy, the smaller the shortage of money becomes, the more money surplus grows.
A stronger dollar, in turn, can put pressure on other currencies and currency pairs.

On the stock market:
Fed rate hikes can hold back stocks, making alternative instruments, such as the same dollar, more attractive. By getting out of risky assets, people protect themselves during periods of economic instability by buying dollars or other less risky instruments.

In the cryptocurrency market:
During periods of economic growth with low Fed rates, cryptocurrency can also be attractive to investors. Such conditions incentivize growth. Such as in 2020, when the Fed took action to mitigate the effects of the COVID-19 pandemic. Markets crashed rapidly after the announcement of the lockdown in the U.S. and the world, in the wake of which the Fed cut interest rates to a record low and launched a quantitative easing program. The U.S. Federal Reserve cut interest rates from 1.5-1.75% to 0-0.25% in March 2020, the sharpest interest rate cut in Fed history. The Fed also expanded lending programs for businesses and consumers. People received free money that started flowing into the markets, which caused risk assets to start rising exponentially. These measures helped prevent a deeper economic downturn at that time. Cryptocurrency markets attracted investors and the market capitalization increased almost manifold. The growth continued into 2021 - that's when BTC set a new high (ATH) at around $69,000. This maximum was reached on November 10, 2021. Sounds very great, however, not everything is so sweet: it is this policy of the Fed, geopolitical circumstances and other factors that resulted in bringing us to the record inflation rate in 40 years.

Federal Reserve Central Bank

Main functions of the Fed

  • Managing a country's monetary policy. The Fed controls the amount of money in circulation to maintain economic growth and price stability.
  • Regulating the banking system. The Fed sets rules and regulations for banks to protect consumers and ensure the stability of the financial system.
  • Ensuring the stability of the financial system. The Fed takes steps to prevent and mitigate financial crises.

How exactly do they manage a country's monetary policy? They use the following tools to do so:

  • Key rate. The key rate is the interest rate at which the Fed lends to commercial banks. Changes in the key rate affect the cost of credit to businesses, consumers, and other borrowers.
  • Open Market Operations. The Fed buys and sells government securities on the open market. Buying securities increases the amount of money in circulation and selling securities decreases it.
  • Reserve regulation. The Fed sets reserve requirements for banks. The more reserves a bank is required to hold, the less money it can lend.

The Fed's actions now and possible future consequences

The U.S. Federal Reserve (Fed) is currently pursuing a policy of tightening monetary conditions to curb inflation.

In July 2022, inflation broke a 40-year record (since November 1981) at 9.1%, to which the Fed responded by continuing to tighten monetary policy. In June 2023, the Fed raised its key rate by 0.75 percentage points, the largest increase in more than 20 years. The rate currently sits at 5.5%. Despite Jerome Powell's recent statements that the situation is already much more favorable because "the Fed is managing to control inflation without a serious increase in the unemployment rate," no one is promising an interest rate cut in the near future. However, the Fed did say at their January 2024 press conference that the rate will begin to decline as soon as they are confident that inflation is falling toward the 2% target. Inflation is currently at 3.1%, with experts expecting it to be 2.9% before the last published figures. This shows that inflation has not actually been defeated yet, and the lag effect is affecting current rates and will affect future rates. An increase in inflation directly affects the actions of the U.S. Federal Reserve and prompts them to take action to control it. The primary method used to control inflation is, of course, raising the prime interest rate.

How are the Fed's actions affecting the economy right now?

A brake on economic growth
Higher interest rates make borrowing more expensive, which leads to slower economic growth. This is because businesses and consumers are less likely to take out loans when they are expensive. This leads to lower investment, consumption and ultimately economic growth.

Reducing inflation
Tightening monetary policy helps the Fed achieve its goals of lowering inflation. Above we have already explained how this happens.

Reducing asset values
Higher interest rates often lead to a decline in the value of "riskier" assets, such as stocks. This is because investors tend to prefer "safer" assets at such times. For example, investing in currencies or gold.

Increased volatility in financial markets
Tighter monetary policy can lead to increased volatility in financial markets as investors lack confidence in the economic and market outlook. This leads to sharper fluctuations in asset prices. In general, the Fed's actions are currently aimed at containing and reducing inflation by slowing economic growth. These actions can have both positive and negative effects on the economy and financial markets. The Fed's current inflation target is 2%, and although it has fallen markedly since the record high of 9.1% in June 2022, rates are now volatile and above market and expert expectations.

The Federal Reserve

How might the Fed's current actions affect the economy in the future?

Since August 2023, we have seen a "swing" in the consumer price index (inflation rate). This suggests that locally the Fed's actions are effective, but at the moment it is not enough. We have received a local minimum of values on inflation. At the moment, high interest rates have an incomplete impact on the markets because there is a lag effect between high rates and economic weakness. Changes in rates only affect new borrowers. Consequently, high rates do not affect those who already have fixed interest debt. The lag effect occurs because there is time before businesses, banks, countries, and ordinary citizens switch to borrowing at the new interest rates. In addition, the U.S. national debt has increased by over 50% in the last 5 years.

The U.S. public debt is the total amount of foreign and domestic obligations that the government is obligated to pay.

The debt has long exceeded 100% of U.S. GDP, meaning it exceeds the country's annual economic output. U.S. government debt has a significant impact on the global economy because the dollar acts as a reserve currency. Many countries hold U.S. bonds and trade in dollars. Debt also has an impact on a country's political decision making. Rising debt can put pressure to cut spending or raise taxes. It also affects a country's monetary policy. However, you can look at it from the other side: the government borrows because they are trying to realize the plans they have in place, including to improve and raise the standard of living of the population. That is, in fact, in the long term, the government debt can have a positive impact on the economic condition of the country, because properly used credit money can bring much greater benefits. In general, we can conclude that while the Fed rate hike does not save the country much, and in the long term, taking into account the effect of delay, such actions of the Federal Reserve can only exacerbate the situation and drive the country into an even greater crisis.

What is real yield?

Fed Chairman J. Powell has stated the Fed's willingness to stand its ground until the economy stabilizes and inflation reaches the 2% mark. This important statement throws light on the concept of "real yield," which takes inflation into account and allows for a more accurate assessment of the purchasing power of an income or investment.

Real yield is calculated as the difference between nominal yield (actual income before accounting for inflation) and the rate of inflation. This indicator allows you to assess how much the purchasing power of money actually increases or decreases with changes in the prices of goods and services.

How is real yield calculated? Real yield = Nominal yield - Inflation rate

Nominal return is the real return on an investment or income before taking into account the effects of inflation. Inflation, in turn, is a measure of the change in the prices of goods and services in the economy, showing how much the general price level is expanding.

Let's look at an example: if you have $1000 and the bank promises you a 5% annualized rate of return, that's the nominal return. If inflation for the year is 3% (prices have risen 3%), your real return will be 2%. This means your income has actually increased by 2%, not 5%. When real yields are high, investors prefer safe assets or those that offer fixed income. Currently, with the Fed raising interest rates, this may keep interest in such assets and keep investors away from risky assets. However, this could change if the Fed decides to ease its monetary policy, leading to lower interest rates. Such events could attract investors by raising asset prices. This is because for many investors, changes in monetary policy are signals for action (not always the right one). At the moment, the Fed is expected to maintain a pause in raising rates, as the current level is sufficient and the full effect is not yet there. The 2% inflation target is realistic, but we need more time to realize the plans. The current raised rate could be a ticking time bomb, worsening the country's economic situation. All this is happening in sync with other problems: energy shortages, real estate market, high level of government debt, strong labor market, external geopolitical problems and others.

The Fed's balance sheet

The balance sheet of the Federal Reserve System (Fed) is a list of the Fed's assets and liabilities. The Fed's assets include government securities, mortgage-backed securities, debt obligations of foreign central banks, gold, and other assets. The Fed's liabilities include bank reserves (funds that banks are required by law to hold in their accounts at the Fed), deposits, debts owed to banks (loans and borrowed funds that the Fed has taken from commercial banks), and other liabilities.The Fed can add and remove liquidity by changing the assets and liabilities on its balance sheet.The Fed adds liquidity by buying assets on the open market. When the Fed buys assets, it pays cash for them. This cash flows into the banking system, increasing bank reserves. Bank reserves are money that banks must keep on deposit at the Fed. The main purpose of the Fed adding liquidity is to stimulate the economy. In this way they lower interest rates and make credit more available to businesses and consumers. The Fed can also withdraw liquidity by selling assets on the open market. When the Fed sells assets, it receives cash for them. This cash is withdrawn from the banking system, reducing banks' reserves. The Fed withdraws liquidity to fight inflation. This is done to raise interest rates and make credit more expensive for businesses and consumers. The balance sheet is the tool the Fed uses to manage the money supply and interest rates.

Is it worth following the Fed's actions, is there any benefit to it: CRYPTOLOGY team's opinion

The impact of the Fed's actions on the US and international markets can hardly be overestimated, as the US economy is one of the strongest in the world, so the actions taken by its central bank affect all markets. It can be seen that before the interest rate is announced, the markets freeze until it is announced. A change in the key refinancing rate, which is one of the Fed's main monetary policy tools, seriously affects the value of stocks, bonds, exchange rates and even the crypto market. When the Fed raises rates, it usually leads to a stronger U.S. dollar and can put pressure on stock prices, as higher rates increase the cost of borrowing for companies. On the other hand, lower rates can stimulate economic activity, which favors riskier markets. In addition, even expectations of Fed policy changes can cause fluctuations in the markets. Fed statements and forecasts influence future price movements. However, it is also important to remember the lag effect, as a rate hike today does not mean that a new "Black Monday" will start right away, it may start a little later when it is less expected, as one Fed action has many consequences.

This is why understanding and analyzing Fed actions allows you to better navigate potential market trends and risks.

Frequently asked questions about the FRS

What is the Fed?

The Federal Reserve System (Fed) is the main bank of the United States of America. The Fed manages the country's monetary policy, regulates the banking system, and ensures the stability of the financial system.

Who's in charge of the Fed?

The Fed is governed by a Board of Governors, which includes the Chairman of the Fed. Currently, the Fed Chairman is Jerome Powell.

What does the Fed do?

The Fed is primarily concerned with managing monetary policy, regulating banking institutions, and ensuring the stability of the financial system.

How does the interest rate affect the economy?

Higher interest rates increase the cost of borrowing, which slows down the pace of economic development. Lower interest rates, on the contrary, make borrowing more affordable, helping to maintain or even accelerate economic growth.

What is the Fed's balance sheet?

The balance sheet of the Federal Reserve System is a financial statement showing the assets and liabilities of the Federal Reserve.
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