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Submitted URL: https://click.mail.edelmanfinancialengines.com/?qs=ab46109e4df32f095e5a02603629644f06418c9d44ed2b9213d822c26b2619983a269b3a8b934601ef93f67a3af9...
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What does the Federal Reserve control?
Edelman Financial Engines
March 6, 2023

By Wei‑Yin Hu, Ph.D., Vice President of Financial Research

The Federal Reserve has dominated news about the financial markets for the past
year. Why is the Fed so important, how does it affect markets and what doesn’t
it do?

The Fed is the “central bank” of the U.S. banking system, and in that capacity,
it can lend money to member banks. You may have read that it is the “lender of
last resort” to banks in times of financial stress. (The Fed also supervises
banks to help ensure the overall system is sound, but that’s not the focus of
this article.) When it lends money to member banks, it sets an interest rate for
those funds called the “federal funds discount rate.” Such loans are short term
in nature – as short as overnight. As a result, the Fed’s decisions to raise or
cut its key lending rate can directly influence short-term rates on loans. The
Fed’s rate decision has less influence on medium- to long-term rates on loans.

The federal funds discount rate is only one of many interest rates. The
direction of the Fed’s key interest rate influences the interest rate offered by
your bank on your checking or savings accounts, the interest rates charged by
credit cards, auto loan or mortgage interest rates, and yields on Treasury bonds
or corporate bonds. However, it’s not the only factor that affects loans. Other
market forces also influence these “consumer” interest rates, such as the supply
and demand for loans of diverse types. Different interest rates will tend to
move together, but not in lockstep. In recent weeks, for example, we have seen
mortgage interest rates decline even though the Fed is still raising the
short-term interest rate it controls.


HOW DOES THE FED’S DISCOUNT RATE AFFECT THE ECONOMY?

As mentioned, the Fed does not directly control medium- and long-term rates
(such as the 10-year Treasury yield). But, to the degree that the Fed’s rate
decisions can have a domino effect up the lending curve, it can affect corporate
and consumer borrowing, and spending. Corporate and consumer activity, in turn,
impacts gross domestic product.

As you might have guessed, the Fed’s rate lever can be a blunt, indirect policy
instrument. The Fed simply does not have the ability to precisely target a 1%
slowdown in corporate investment, for example. Every time the Fed announces an
interest rate change, or even when it makes statements that cause market
observers to change expectations about future rate changes, financial markets
are updating their estimates of how much the Fed’s policy will affect economic
activity. Given how much is out of the Fed’s control, however, these predictions
are subject to a lot of error.


WHAT DOES IT MEAN FOR INVESTORS?

The Fed’s aim is to maintain high employment and low inflation. It is constantly
digesting the latest economic data to determine how much to move interest rates.
It is anyone’s guess as to whether and when it will be able to bring inflation
under control without causing a recession. That means continued uncertainty in
bond and stock markets, so you should stick to a long-term strategy rather than
make portfolio changes based on short-term market movements. In the end,
although there are never guarantees when investing, history suggests that a
well-diversified portfolio will grow over the span of several years, even if
there are large economic and market dips along the way.




INVESTING VS. SPECULATION

In this episode of Everyday Wealth™, Jean Chatzky is joined by wealth planner
Andy Smith to discuss the differences between speculation and investing. They
also discuss whether it’s better to lease or buy a car in the current economy,
and later in the episode, Dr. Wei Hu, vice president of financial research at
Edelman Financial Engines, joins Jean and Andy for Investing Sense, where they
talk about mental reference points that impact investing.

LISTEN NOW:
https://www.edelmanfinancialengines.com/everyday-wealth/replay-investing-vs-speculation/

© 2023 EDELMAN FINANCIAL ENGINES, LLC. THIS PUBLICATION IS FOR INFORMATIONAL
PURPOSES ONLY AND DOES NOT CONSTITUTE INVESTMENT ADVICE OR AN OFFER TO BUY OR
SELL ANY SECURITY. FUTURE MARKET MOVEMENTS MAY DIFFER SIGNIFICANTLY FROM THE
EXPECTATIONS EXPRESSED HEREIN, AND PAST PERFORMANCE IS NO GUARANTEE OF FUTURE
RESULTS. EDELMAN FINANCIAL ENGINES ASSUMES NO LIABILITY IN CONNECTION WITH THE
USE OF THE INFORMATION AND MAKES NO WARRANTIES AS TO ACCURACY OR COMPLETENESS.
FUTURE RESULTS ARE NOT GUARANTEED BY ANY PARTY. FINANCIAL ENGINES® IS A
TRADEMARK OF EDELMAN FINANCIAL ENGINES, LLC. ADVISORY SERVICES ARE PROVIDED BY
FINANCIAL ENGINES ADVISORS L.L.C. (FEA), A FEDERALLY REGISTERED INVESTMENT
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SERVICES LIMITED. BLOOMBERG® IS A TRADEMARK AND SERVICE MARK OF BLOOMBERG
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AFFILIATES, “BARCLAYS”), USED UNDER LICENSE. BLOOMBERG OR BLOOMBERG’S LICENSORS,
INCLUDING BARCLAYS, OWN ALL PROPRIETARY RIGHTS IN THE BLOOMBERG BARCLAYS
INDICES. NEITHER BLOOMBERG NOR BARCLAYS APPROVES OR ENDORSES THIS MATERIAL, OR
GUARANTEES THE ACCURACY OR COMPLETENESS OF ANY INFORMATION HEREIN, OR MAKES ANY
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THE MAXIMUM EXTENT ALLOWED BY LAW, NEITHER SHALL HAVE ANY LIABILITY OR
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FOR USE. S&P®, S&P 500® AND S&P SMALL CAP 600®, AMONG OTHER FAMOUS MARKS, ARE
REGISTERED TRADEMARKS OF STANDARD &AMP; POOR’S FINANCIAL SERVICES LLC, AND DOW
JONES® IS A REGISTERED TRADEMARK OF DOW JONES TRADEMARK HOLDINGS LLC. ©2019 S&P
DOW JONES INDICES LLC, ITS AFFILIATES AND/OR ITS LICENSORS. THE MSCI INFORMATION
MAY ONLY BE USED FOR YOUR INTERNAL USE, MAY NOT BE REPRODUCED OR RE-DISSEMINATED
IN ANY FORM AND MAY NOT BE USED TO CREATE ANY FINANCIAL INSTRUMENTS OR PRODUCTS
OR ANY INDICES. THE MSCI INFORMATION IS PROVIDED ON AN “AS IS” BASIS AND THE
USER OF THIS INFORMATION ASSUMES THE ENTIRE RISK OF ANY USE MADE OF THIS
INFORMATION. MSCI, EACH OF ITS AFFILIATES AND EACH OTHER PERSON INVOLVED IN OR
RELATED TO COMPILING, COMPUTING OR CREATING ANY MSCI INFORMATION (COLLECTIVELY,
THE “MSCI PARTIES”) EXPRESSLY DISCLAIMS ALL WARRANTIES (INCLUDING, WITHOUT
LIMITATION, ANY WARRANTIES OF ORIGINALITY, ACCURACY, COMPLETENESS, TIMELINESS,
NON-INFRINGEMENT, MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE) WITH
RESPECT TO THIS INFORMATION. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT
SHALL ANY MSCI PARTY HAVE ANY LIABILITY FOR ANY DIRECT, INDIRECT, SPECIAL,
INCIDENTAL, PUNITIVE, CONSEQUENTIAL (INCLUDING, WITHOUT LIMITATION, LOST
PROFITS) OR ANY OTHER DAMAGES.

 

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