There are many factors worth monitoring when following the stock market and economy. Economic data, geopolitical events, and quarterly earnings reports from companies are some of the most watched items for investors. An independent part of the government that is often overlooked, or simply misunderstood by the public, is the Federal Reserve (Fed). That is a big mistake and let me explain why.
The Federal Reserve was created in 1913 to be the central bank of the United States. The goal of the Fed is to provide a safer, more flexible, and more stable monetary and financial system. Their mandate from Congress is to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy. Easier said than done, but more times than not, they are good at what they do. When everything is going smoothly in regards to the U.S. economy, the Fed is mostly waiting patiently on the sidelines. When the economy turns south that is where people, rightfully so, listen to every word the Fed has to say.
The most influential part of the Fed is the Federal Open Market Committee (FOMC). The FOMC is the body that sets national monetary policy. The open market operations include setting interest rates (federal funds rate& discount rate), and the size and composition of the Fed’s asset holdings. These tools are much stronger than the general public realizes. Fiscal policies, which involve government spending and levied taxes, are closely watched by investors. The Fed has more firepower, and secondly can act much quicker than Congress, in my opinion. To spur economic growth the Fed can lower the interest rate banks borrow money from the Fed (discount rate), or the rate banks charge each other for borrowing money(federal funds rate). These rates effectively determine how much money banks have available to lend to their customers.
Quantitative Easing (QE) is an expansion of the FOMC tools and is only used during financial crises, after the FOMC has lowered the fed funds rate to zero. This occurred during the 2008 financial crisis and more recently during the pandemic. QE is where the Fed buys massive amounts of securities (US Treasuries, mortgage bonds, and more recently corporate bonds) to help lower interest rates and provide liquidity to the financial markets. The total assets on the Fed’s balance sheet have gone from $900 billion before the 2008 financial crisis to now more than $6 trillion. Due to the scope and size of QE in recent years, many observers are worried about the possible negative repercussions of these actions. It’s really unprecedented, so hard to say what occurs, but many parties will be closely watching.
In conclusion, the Federal Reserve is the elephant in the room that’s worth monitoring very closely.