Lately we’ve been highlighting the impact of the Fed’s monetary policy on the economy and the stock market in our weekly market insight emails. But what exactly does the Fed do and how do they influence the economy and the stock market?
First, a little backstory. The Federal Reserve System is America’s central banking system, created in 1913 to establish centralized control of the monetary system and to minimize financial crises. A part of this organization, the Federal Open Market Committee (FOMC) is an independent government agency made up of seven members, called governors, who are nominated by the president. They meet eight times per year to set monetary policy with specific mandates for maximizing employment, stabilizing prices, and moderating long-term interest rates. We generally simplify these mandates to maximizing employment and keeping inflation around 2% annually.
What the FOMC does and does not do to achieve these goals:
- They do determine the federal funds rate which is the interest rate banks lend to other banks.
- They do not directly determine mortgage rates, loans, and savings rates for consumers. However, these rates are influenced by the federal funds rate.
- They do make decisions with the goal to create a smoothly functioning economy (which the stock market benefits from).
- They do not make monetary decisions to specifically influence the stock market.
- They do make plenty of mistakes in monetary policy because they are deciding on current policy changes that will take months or years to be felt in the economy. It’s not a perfect science.
In short, the Fed steers the economy which then affects the stock market and your portfolio, and due to the high inflation cycle the economy is currently going through, it’s more crucial than ever to pay attention to their policies.
Photograph by: Ryan Quintal on Unsplash