Structure of The Federal Reserve and Why Does the Market Care so Much
We hear about the Federal Reserve (the Fed) in the financial news all the time and we have written about the Fed in our weekly Market Updates. Most investors realize that the Fed is important, but they are not aware of the details on how it operates. Therefore, we thought it would be a good idea to take a step back and describe the basic structure of the Federal Reserve.
The Federal Reserve System is the central bank of the United States. It has five main functions that help the U.S. economy run effectively (see the diagram below).[i] The Fed system is divided into three key entities; the Federal Reserve Board of Governors, the 12 Federal Reserve Banks and the Federal Open Market Committee.
We will focus on the Federal Open Market Committee (FOMC) because that is the entity within the Fed that most influences the financial markets through monetary policy. There are 12 members in the FOMC, of which seven are Board of Governors and the remaining members are Reserve Bank presidents, who serve one-year terms on a rotating basis.[ii]
The FOMC impacts the federal funds rate, the rate at which banks charge each other to meet overnight deposit requirements, through the purchase and sells of government bonds. This rate in turn effects other short-term rates, such as credit cards and auto loans.
The financial markets care about the Fed decisions because if they raise rates, it hurts the economy and if rates fall, it helps the economy. The Fed is expected to lower rates in its upcoming meeting later this month and the markets expect the rates to continue to decrease going into 2020.
If that turns out to be the case, it is likely that our economic expansion will continue, which is positive for the U.S. stock market.
[i] Source: https://www.federalreserve.gov/aboutthefed/structure-federal-reserve-system.htm
[ii] Source: https://www.federalreserve.gov/monetarypolicy/fomc.htm