What if you heard that your mortgage rate may decrease, your bank’s savings rates could go up, or the economy may be vulnerable to another slowdown? What if this news is coming from some of the most powerful people in the world?
Sound important?
Only a handful of people truly have the ability to influence the U.S. economy. Warren Buffett may be able to move markets for a few days at a time, but in the U.S., a group of about a dozen individuals has the power to chart our country’s economic course for months, years, even decades. As you can imagine, when these people speak, the markets listen.
Back in 1913, following a particularly nasty recession, Congress authorized an organization to control the value of each dollar in our pockets. Ever since, the Federal Reserve has made policy that affects the lifeblood of our economy, our currency.
The Federal Reserve is the main influencer of the availability and cost of money and credit in our economy. You’ve heard this powerful cabal referred to as the Fed, but you may not understand what exactly makes it so important.
First, it’s important to know the Fed’s mandate, which in the Federal Reserve Act is officially “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Because long-term interest rates can remain low only in a stable macroeconomic environment, the goals are often referred to as the dual mandate of 1) maximum employment and 2) protecting the value of the dollar.
To protect the value of anything, one has to control its supply. By using its tools to control the way banks hold and disperse money, the Fed controls how many dollars are floating around the world, or these days, being zapped electronically throughout the world. You may not know it, but your decisions about borrowing, lending, saving and spending are all influenced by Fed policy.
The most well-known of the Fed’s policy tools are the actual setting of the discount rate and the setting of a target federal funds rate. Twelve members of the Federal Reserve System make a proposal as to the rates and the seven members of the Board of Governors vote yes or no. The markets wait with bated breath when they know a vote is in progress.
While the discount rate is important to banks, knowing the federal funds rate is vital to the individual investor. The rate on any consumer or business loan first starts with the federal funds target rate, with banks adding percentage points to account for the additional risks they take to extend the loan.
It’s not hard to see that changes in key rates can lead to a chain of events that affect individuals immensely; consumer interest rates, home mortgage rates, and a plethora of other credit sources are based on the federal funds rate. To benefit from potential interest rate changes, you need to keep track of what Fed officials are saying.
Fed officials are required to disclose their thoughts to the public through formal statements, and the Fed Chairman reports to Congress on a regular basis. Additionally, individual Federal Reserve officials often talk individually, making their views known through individual interviews or speaking engagements. If you can see where the decision-makers are coming from and where they want to go, future interest rates, especially short-term rates, can be somewhat predictable.
Interest rates are one of the market inputs that regular Joes have a fairly good chance of forecasting, due to the public nature of Federal Reserve disclosures. Keep an eye out for news articles that report what Fed officials are saying. You probably won’t be able to use the information to get an inside track on Wall Street, but you can use it to make high-impact personal decisions, like refinancing your mortgage while rates are still low, or waiting to buy bonds if it looks like interest rates will rise. If you don’t pay attention to what the Fed is telling you, you’re essentially playing solitaire with a deck of 51.
