As an investor, you’ve probably heard a lot about the FED, and each of its meetings on interest rate hikes tends to cause significant market fluctuations. So, what is the FED? How powerful is it? Why does the FED raise interest rates? And how does the FED raising rates impact cryptocurrencies, gold, stocks, or interest rates in Vietnam? Let’s explore the detailed answers in the content of this article.
Contents
What is the FED?
FED is an abbreviation for the Federal Reserve System, known as the central bank of the United States and currently considered the most powerful financial institution in the world.
The Federal Reserve System (FED), established in 1913, is tasked with ensuring a stable, adaptable, and secure monetary framework. It uniquely oversees the creation and distribution of currency and credit, upholds financial stability, and offers banking services. The Federal Open Market Committee (FOMC), a key component of the Fed, regulates the U.S. money supply through its monetary policy decisions.
Unlike conventional institutions, the FED isn’t owned by any individual or entity. It comprises 12 Federal Reserve Banks, each serving a distinct region of the United States, collaboratively working to fulfill the Fed’s mandate.
How Powerful is the FED?
As mentioned earlier, the FED has the authority to act to ensure financial stability and manages the member banks of the Federal Reserve System. The FED plays the role of the lender of last resort to member institutions with nowhere else to borrow. It also acts as the primary regulator of the country’s financial institutions.
The 12 member banks of the FED are regional federal banks, including Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.
The Fed’s mission can be focused on four areas:
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Regulating the national monetary policy by influencing monetary and credit conditions in the U.S. economy to ensure maximum employment, stable prices, and moderate long-term interest rates.
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Supervising and regulating banking institutions to ensure the safety of the U.S. banking system’s financial system and to protect consumer credit rights.
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Maintaining the stability of the financial system and managing systemic risks.
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Providing financial services, including a critical role in operating the national payment system, depository institutions, the U.S. government, and official foreign institutions.
Importantly, the FED is independent, capable of acting without needing approval from the President or any government agencies. However, it is still subject to Congressional oversight and must operate within the framework of the government’s economic and fiscal policy goals.
The power of the FED is demonstrated through the following rights:
- The FED can change interest rates: changing interest rates directly affects the USD, thus impacting U.S. monetary policy and the financial activities of businesses and international investors.
- Buying and selling government bonds: Buying bonds increases the money supply, decreases interest rates, and stimulates spending and banking. Conversely, selling bonds decreases the money supply, increases interest rates, and tightens the financial market.
- Deciding the cash reserve amount: As the FED directly regulates and supervises the 12 Federal Reserve banks, when the FED changes policies, these banks must comply. For example, if the FED requires an increase in money reserves, interest rates will rise, making lending and credit activities more challenging.
Why does the FED influence the global economy?
Following global financial news, you may notice that every decision of the FED is of great interest to investors. So, what is the FED, and why do its decisions have such a significant global impact?
To explain this, let’s go back in history. After World War II, the U.S. emerged as the victor. While allied countries suffered heavy damage, the U.S. benefitted the most and held up to ¾ of the world’s gold reserves.
=> This made the U.S. dollar the world’s most powerful currency. It is seen as a fiat currency that can be widely used globally. All import and export activities worldwide are directly or indirectly related to the USD.
=> Therefore, every time the FED changes its monetary policy, the global financial market is sure to change accordingly.
For example, if the FED raises interest rates, inflation will be curbed, strengthening the USD’s power in the international currency market, leading to changes in the import-export balance and investment in the U.S. Naturally, all countries trading with the U.S. or using the USD will also be significantly affected.
Additionally, changes in monetary policy directly impact international investors or traders as the USD is the main currency for transactions.
What does it mean when the FED raises interest rates?
The Federal Reserve’s interest rate (Fed Funds Rate) is the basis for U.S. commercial banks to set interest rates for short-term INTERBANK loans. The interest rate that the FED raises is the rate at which banks lend to each other overnight. Although it is not the interest rate applied to consumers, the FED’s actions still affect the LOAN INTEREST RATES that people see daily, such as home and car loans…
Why does the FED raise interest rates?
The FED uses the tool of raising interest rates as a plan to reduce inflation in the country. According to recent U.S. data, annual inflation in the country has reached 6.6% (the highest in 40 years). Therefore, the market predicts the FED will continue to raise interest rates until at least the end of this year to bring inflation back to the 2%/year target.
Discussing the relationship between interest rates and inflation:
When the FED raises interest rates, commercial banks will also increase lending rates. This naturally reduces the demand for money. Instead of borrowing or spending money, people prefer to deposit money in banks to enjoy high interest rates. Reduced consumer demand will cause goods prices to drop. => Inflation will decrease.
When interest rates decrease, the interest rates on loans will also decrease. This will encourage people to borrow more money, leading to increased money circulation and spending. => The value of the currency decreases, goods prices rise => Inflation increases.
Regarding the root causes of inflation in the U.S.:
- Supply chain bottlenecks are pushing up commodity prices.
- Energy prices are rising due to reduced supply, along with the conflict between Russia and Ukraine.
- Mismatched supply and demand in the labor market are also driving higher wages, leading to price increases.
However, apart from regulating inflation, the FED may also decide to raise interest rates based on other factors, such as:
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A heated economy: In a strong economic growth context, raising interest rates might not be enough to cause a recession. Raising interest rates at this time is necessary to prepare for a rate cut in case of an unexpected economic downturn.
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Current low-interest rates: Real interest rates equal the announced interest rate minus the inflation rate. If the real interest rate is still low, the FED may consider raising this rate.
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FOMC wants to bring interest rates to an average level: According to economic experts, interest rates have been trending downward in recent years. In this context, the FOMC wants to raise interest rates to an average level.
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Preventing excessive lending: Raising interest rates can somewhat curb excessive consumer lending activities. Simultaneously, it prevents real estate bubbles.
How does the FED raising interest rates impact?
What is the FED? how will the FED raising interest rates impact, and who will be affected?
FOR U.S. CITIZENS:: Americans will seek ways to reduce their debt, especially high-interest credit card debts or loans with variable market-based interest rates. Simultaneously, they will also need to increase savings and limit spending.
Besideshe, Federal Reserve (FED) raising interest rates has several significant impacts on the economy, financial markets, and individual consumers:
- Costlier Borrowing: Higher interest rates make borrowing more expensive. This applies to both individuals and businesses. For individuals, it means higher rates on mortgages, car loans, and credit cards. For businesses, it increases the cost of financing for operations and expansion, which can slow down investment and growth.
- Influence on Inflation: Increasing interest rates is often used as a tool to combat inflation. Higher rates can reduce consumer spending and business investment, leading to slower economic growth and, potentially, lower inflation rates.
- Stock Market Reaction: Generally, higher interest rates can lead to lower stock market returns. Companies face higher borrowing costs, which can reduce their profits. Furthermore, investors may shift their preference from stocks to fixed-income investments like bonds, which become more attractive as interest rates rise.
- Bond Prices and Yields: There is an inverse relationship between bond prices and interest rates. When interest rates rise, bond prices typically fall, and their yields increase. This can affect the value of fixed-income portfolios.
- Impact on Savings: Higher interest rates can be beneficial for savers as the returns on savings accounts and other deposit products typically increase. However, this benefit may be offset by higher inflation.
- Exchange Rates: Higher interest rates in the U.S. can lead to a stronger dollar as investors seek higher returns on dollar-denominated assets. This can impact international trade, as a stronger dollar makes U.S. exports more expensive and imports cheaper.
- Real Estate Market: Higher mortgage rates can cool down the real estate market. Buying a house becomes more expensive, which can reduce demand and slow down home price increases.
- Consumer Behavior: As borrowing becomes more expensive and saving yields more, consumers may cut back on spending and increase their savings. This can lead to reduced consumer demand, affecting economic growth.
- Sector-Specific Impact: Different sectors of the economy may react differently to interest rate hikes. For instance, financial institutions might benefit from wider interest margins, while sectors that rely heavily on borrowing, like real estate and consumer discretionary, may face challenges.
- Government Debt: Higher interest rates increase the cost of servicing government debt. This can have significant implications for government budgets and fiscal policy.
How the FED Raising Interest Rates Affects Gold, Cryptocurrency, and Stock Prices
What is the FED? Does gold increase or decrease when the FED raises interest rates?
How does the FED raising interest rates impact the cryptocurrency market?
Do stocks increase or decrease when the FED raises interest rates?
Theory: Theory: The FED plays a decisive role concerning the USD, so its actions greatly impact these investment channels. When the FED raises USD interest rates, money will shift from gold to the USD, causing gold prices to drop.
Reality: Sometimes the FED raises interest rates during economic turmoil. Gold is often considered the safest financial haven in such chaotic situations. Therefore, sometimes gold and USD can fluctuate in the same direction.
In other investment channels, many cryptocurrency or U.S. stock investors find it more beneficial to save rather than invest, leading them to deposit their money in savings accounts instead of investing. This will lead to a decrease in demand, causing these investment channels to trend downwards.
For example: Before news that the FED will raise interest rates far beyond expectations, the cryptocurrency and U.S. stock markets tend to fall sharply.
However, the FED raising interest rates does not always negatively affect the market; it depends on the specific timing, investment channel, and policies of each country. As an investor, you should thoroughly understand what is the FED and always pay attention to the FED’s interest rate changes, as well as combine this with other macroeconomic news to find a suitable investment strategy in this volatile market. Wishing you success.
