5 Jargon Words Explained in Finance — “Fed” aka Federal Reserve Edition
The Fed probably plays the most crucial role in the US economy and in the world economy. Yet most people have little idea how the Fed works, what it actually does and why its decisions have so much impact. Let’s break down the basics and jargon used when talking about the Fed so you become a Macro-econ pro.
Federal Reserve
The Fed is the Central Bank of the United States, it regulates the country’s financial institutions. It’s comprised of a network of 12 Federal Reserve Banks and a number of branches. This is all overseen by the Fed’s Board of Governors, a group of ballers who make important decisions. It’s important to note that the Fed is an independent agency — which means it can make decisions on its own, without needing approval from any other branch of government. The caveat — Fed board members are nominated by the President and must be approved by the Senate.
What does the Fed do?
The Fed has a mandate to promote sustainable growth, high levels of employment, stability of prices to help preserve the purchasing power of the dollar and moderate long-term interest rates. And you thought passing Calculus was hard.
Basically the Fed’s role is to control inflation and to ensure full employment in the US, not an easy task.
It has many tools at their disposal to control the economy and employment:
- Interest rates — including raising/lowering the discount rate and Fed funds rate (explained below)
- Reserve requirements — how much banks need to hold in deposits against lending the deposits out
- Open market operations — buying/selling Treasury (Gov) bonds
Oh and it also conducts important economic research in the form of the beige book that comes out every month.
Janet Yellen
Is the head of the Fed, the current chairwoman, the big Kahuna. Arguably this is one of the most important positions held in the world, as everything she says can can move markets and influence other countries policies. She is also the first woman to hold the position (supppp progress). By law she needs to testify before Congress twice a year to talk about her policies and the economy — 💰
FOMC
This is the group within the Fed that makes the decisions. FOMC stands for the Federal Open Market Committee. The FOMC meets eight times per year to set key interest rates and to decide whether to increase or decrease the money supply — which the Fed does by the tools mentioned above.
The FOMC consists of 12 members — the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the other 11 Reserve Bank presidents. After they conclude their 2 day long meetings, they release the results of whether they decided to raise, lower or not change interest rates. This decision can put the market into a major frenzy as it did on March 18th 2015 (see chart!)
Fed funds rate 💸
Ever wondered what drives the interest rates in your checking, student loans, car loans etc? Well it’s all driven by the Fed, and specifically the “Fed funds rate” which they decide to act on during FOMC meetings. This is the interest rate at which banks and credit unions lend reserve balances to each other every day — aka Chase lends Bank of America $800m dollars on Tuesday at the Fed funds rate.
It has a major impact on daily lives of nearly every American. As we mentioned above, the Fed can raise interest rates to slow down the economy. That means buying a home or a car can be more expensive if you have to pay more interest on a loan. There is a lot of talk now that the Fed will raise rates in December — this will have an effect (slow and steady) on the overall economy and you.
Similar to raising rates, the Fed can also cut back on buying government bonds. This means it is lowering the amount of money circulating in the economy — and creating less consumer spending. Of course, the opposite is true. If the Fed lowers interest rates and borrowing costs, that makes a home or car purchase cheaper. And that could also mean businesses would borrow money at a cheaper rate and think about hiring if the economy picks up steam and consumers are spending 🎢.
PS: you can create real time Fed Funds Rate triggers in Trigger 🙌
Hawkish 🐦 /dovish 🕊
This is typical Wall Street lingo and jargon that is meant to both confuse you but also save people time explaining themselves on the trading floor. You can think of these 2 words as a bullish/bearish analogy for stocks, but in here it applies to interest rates.
Central bankers aka Yellen and co are described as “hawkish” when they are in support of the raising of interest rates to fight inflation, even at the cost of slowing economic growth and employment. “Dovish” central bankers, on the other hand, generally favor economic growth and employment over raising interest rates. They also tend to have a more passive stance when reacting to a an economic event or action.
If you have more Fed or other jargon that you’d like to see broken down, let us know! Now go off young grasshopper and brace yourself — for the Fed is coming.
