Five reasons to pay attention to the Federal Reserve
By: John R. Coble, III
We hear frequent references in the news to the Federal Reserve (or the “Fed,” as it is more commonly called). Yet, for many individual investors and consumers, the way the Fed affects their lives is a bit cloudy. So, let’s clear the air.
Decisions by the Federal Reserve can have major impacts to your financial life. The Fed serves as the nation’s central bank and while it has a fair degree of independence, it is directly accountable to Congress. Among its primary duties, it provides oversight of the banking and financial services industries and establishes monetary policy.
Here are five key ways the actions of the Federal Reserve can impact your financial life:
#1 – The interest you pay for a mortgage, auto loan or other borrowing
One of the key monetary policy functions of the Federal Reserve’s Open Market Committee is to set the Federal Funds interest rate. This is a rate charged when banks borrow and lend funds from one another. That does not directly determine what banks and other institutions will charge for consumer loans like mortgages or auto financing, but it does have an indirect impact. If the Fed is lowering or raising interest rates, a similar trend is likely to follow for other types of borrowing.
#2 – Changes in your cost of living
One of the mandates of the Federal Reserve is to try to manage the inflation rate. The level of change in the cost of living from year to year can have a major impact on your bottom line. The Fed seeks to keep the annual inflation rate at two percent or less. It has generally succeeded in maintaining that level in recent years. But it structures monetary policy to respond to current economic conditions in order to keep the inflation rate in check.
#3 – The employment environment
Another of the Fed’s mandates is to maintain what is referred to as “full employment,” an environment where most who are seeking work can find it. The Fed tries to accomplish this by managing monetary policy to create favorable conditions so employers can hire more workers. This mandate has to be balanced with the desire to maintain a modest rate of inflation.
#4 – Short-term investment performance
Again, the Fed does not have any direct impact on investment markets, but its monetary policy stances, including interest rate policies, are closely watched, particularly by investment professionals. Stock and bond markets can fluctuate depending on expectations of Fed actions or specific policies it implements.
#5 – Earnings on bank savings
Banks will often adjust the rates they pay for Certificates of Deposit (CDs) or interest-bearing accounts based on the Fed’s interest rate policy. Yields will improve when the Fed is raising short-term interest rates, but will decline if the Fed decides to cut rates.
To determine your financial position in light of the current state of the Fed’s policies, it may makes sense to sit down with a financial advisor and review your portfolio.