Why does the Fed matter? Because its policies move the market

Market Realist

Must-know: Interpreting FOMC statements (Part 1 of 4)

With the Fed driving markets, investors need to be bilingual

With monetary policy a huge driver of investment performance, all investors need to be fluent in “Fedspeak.” Fedspeak is the carefully chosen wording that the Federal Reserve uses in press releases and speeches in order to influence market expectations of its future actions regarding interest rates and the growth rate in the money supply.

But why does the market care? Because the Fed controls the money supply, its actions and expected actions have a massive impact on the inflation rate and therefore on nominal growth in output (which is real output growth plus inflation). Future growth affects the profitability of investments, and so current asset prices, such as stocks. The actions of central banks such as the Fed are incredibly important, and investors ignore them at their own peril.

The Fed’s policies are moving the market

The Fed is currently following two policies that affect the economy: a zero interest rate policy (ZIRP) and a third round of quantitative easing (QE3). ZIRP is the Fed’s targeting of the Federal Funds Rate, the rate at which banks lend to each other overnight, at between 0% and 0.25%. QE3 is the Fed’s purchasing of $40 billion of mortgage-backed securities and $45 billion of Treasury bonds each month in order to increase the money supply. Together, the Fed is trying to increase output and investment by influencing investors’ growth expectations.

The Federal Open Market Committee (FOMC) is the group within the Fed that determines the central bank’s actions. Every month, the FOMC meets and has a press release stating its views on the economy and any policy changes. The economic and market indicators that the Fed believes are important are discussed. These include unemployment, household spending, business investment, inflation and inflation expectations, asset prices, and fiscal policy.

Read on to find out which economic indicators really matter to the Fed and what you should pay attention to.

Continue to Part 2

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