The Federal Reserve System (the Fed) was established in 1913 by the US Congress. The Fed’s actions and policies have a major impact on the currency value and affect many transactions with the US dollar. Read more about the Fed’s history, its influence on the USD and how you can trade the Fed’s monetary policy decisions.
WHAT IS THE FEDERAL RESERVE?
They are the central bank of the United States. It was created to create a stable, flexible monetary and financial system for the nation. His general duties are to determine monetary policy and to monitor an effective economic operation that ultimately serves the public interest.
To meet these top-level guidelines, the Fed performs five general functions:
- They Promote the maximum employment, stable prices and moderate long-term interest rates where possible, reduce the risk of creating a stable financial system
- Develop security within financial institutions
- Champion security within payment and settlement systems
- Calls for consumer protection through a supervisory attitude.
- To perform daily operations, the nation is divided into 12 Federal Reserve Districts, each of which is served by a separately listed Reserve Bank. These districts and affiliated banks operate independently under the supervision of the Federal Reserve Board of Governors.
Who owns the Fed?
The Fed is both a private and a public institution. The Board of Directors is a government agency, while the banks themselves are structured as private companies – affiliated banks hold shares and earn dividends.
Who is the President of the Federal Reserve?
From August 2019, the Chairman of the Federal Reserve is Jerome Powell, who has been in this office since 5 February 2018. He is the 16th person to hold the position and will complete a four-year term. Prior to his appointment, Mr Powell was a member of the board of directors from 25 May 2012. He is currently also chairman of the Federal Open Market Committee, which looks after monetary policy.
Which banks does the Fed consist of?
Here are the 12 Federal Reserve Districts, each with their own Reserve Bank, are:
- New York
- St. Louis
- San Francisco
How is the Fed held responsible for its functions?
The Fed is accountable to the public and to the US Congress. The President and Federal Reserve officials testify before Congress, while the monetary policy system is clear and transparent. In the interest of accountability, the Federal Open Market Committee (FOMC) will publish statements after all annual meetings. All financial statements are independently audited once a year to also guarantee financial accountability.
Understanding the FOMC is the key to understanding the Fed.
MAIN ECONOMIC MANDATES OF THE FEDERAL RESERVE SYSTEM
The US monetary policy is the core mandate of the Federal Reserve bank. The legal objectives of this monetary policy are set out by Congress and are:
- Maximum employment: the FOMC’s monetary policy must ensure that unemployment remains low and works to stimulate the economy where necessary, so that businesses thrive, make a profit, and hire more staff to grow
- Talking about Price stability: the Fed defines price stability as an inflation rate of 2% in the long term
- Moderate long-term interest rates: this works in conjunction with price stability – when an economy is stable, long-term interest rates remain at a moderate level the Fed wants to achieve its monetary policy through its influence on interest rates and the general financial environment. This can lead to US dollar volatility, prior to Fed announcements and policy changes.
Federal Open Market Committee
Monetary policy is determined by the Federal Open Market Committee (FOMC), which oversees the open market activities of the Federal Reserve System. They set a target for the federal fund rate at FOMC meetings; this is the interest rate that banks want to offer each other for overnight loans. Although the FOMC does not manage the speed, it can be influenced in three ways:
- Open market operations. This means buying and selling government bonds on the open market – sales bonds reduce the monetary offer with the aim of increasing interest rates. Buying bonds brings money back into the economy, with the aim of reducing interest rates
- Discount percentage. These are the rate that banks pay to borrow money from the Fed. If this rate is lower, it is also more likely that the rate of the federal funds will also be lower
- Reserve requirements. Bank need to hold a certain percentage of customers’ deposits to cover withdrawals – this is the reserve requirement. When these are raised, banks can’t loan as much money and must ask for higher interest rates. When lowered, banks can loan more money and ask for lower interest rates.
HOW DOES THE FEDERAL FUNDS AFFECT THE US DOLLAR?
The interest rate of the Fed, also known as the Fed funds rate, is set by the Board of Directors of the Federal Reserve System. Therefore, the current interest rate and the expectations of future interest rate changes can both affect the value of the US dollar. If traders anticipate an interest rate change based on announcements from the Governing Council, this may cause the Dollar to value or fall in value against other currencies.
This table shows how market expectations and price changes can influence the value of the dollar: