What the Federal Reserve does, and why markets watch it
The US Federal Reserve sets the interest rate that ripples through loans, savings and share prices. Here is how it works in plain English.
Few things move markets like a decision from the US Federal Reserve, usually called "the Fed". Here is what it does and why investors in both the US and Canada pay attention.
What the Fed is
The Federal Reserve is the central bank of the United States. Congress has given it two main goals: as many people in work as possible, and stable prices. In practice, "stable prices" means aiming for inflation of about 2% a year.
Its main tool: the interest rate
The Fed sets a target for the federal funds rate. That is the rate banks charge each other for overnight loans. It sounds narrow, but it feeds into the rates on mortgages, car loans, credit cards and savings accounts.
- To cool inflation, the Fed raises rates. Borrowing gets more expensive and spending slows.
- To support a weak economy, the Fed cuts rates. Borrowing gets cheaper and spending picks up.
When it decides
A Fed committee, the Federal Open Market Committee, meets eight times a year to set rates. The decision is announced in the afternoon, Eastern time, and the Fed chair usually answers reporters' questions afterward. Markets often move during that news conference, not just at the announcement.
Why Canadians care
US interest rates affect the value of the Canadian dollar, Canadian bond yields and the shares of Canadian companies that do business in the US. The Bank of Canada makes its own decisions, but it watches the Fed closely. See What the Bank of Canada does.
The short version
- The Fed is the US central bank.
- It raises rates to fight inflation and cuts them to support the economy.
- Markets react to what the Fed says about the future as much as to the decision itself.
This is general information, not investment advice.
Updated