Understanding the Federal Reserve and Its Impact on Current Events

In our most recent episode of What’s Your 1 More, we delved into the actions of the Fed. We broke down what drives their decisions and the implication of those decisions on the market. 

To fully absorb the key factors of what we covered, here I’ll break down some key concepts that will build context for why the Fed’s actions are so significant—and, at times, controversial.

How the Fed’s Actions Impact Everyday Life

Whether you’re setting up payments for a new car or buying a house, when it comes to monetary policy, what the Federal Reserve does matters. Their actions affect things like inflation and interest rates, which in turn, affects consumers.

For example, changes in interest rates can affect mortgage payments or investments in stocks and bonds. While it’s not a direct causality, there is usually a correlation between a rise in interest rates, mortgage rates, and stock market fluctuations.

Higher interest rates mean higher borrowing costs to finance everything from your new home to a credit card purchase. When the Fed increases interest rates, the money available in the economy tends to decrease—another factor making it more expensive to borrow. Sometimes, the market shifts based merely on speculation that the Fed will hike rates.

It also explains how inflation affects consumer prices and wages and what investors should consider when making long-term decisions. 

Another critical thing to note is that when the Fed introduces a new policy shift, they often don’t receive the effects of that shift until much later down the road due to lagging data. So while we feel the impact, you may not see another change for several months. 

Quantitative Easing vs. Tightening

Quantitative easing and tightening are two opposite monetary policy tools used by the Federal Reserve to regulate the economy. Understanding the difference between the two is crucial for anyone interested in navigating the market’s current climate.

Quantitative easing is when the Fed creates new money and uses it to purchase government bonds or other financial assets in the open market. The aim is to increase the money supply, lower interest rates, and stimulate economic growth. We saw the Fed used this method during the financial crisis of 2008 as a response to the credit crisis.

On the other hand, monetary tightening, also known as quantitative tightening, is a policy that reduces the money supply by selling government bonds or other financial assets. 

The aim is to increase interest rates and reduce inflation. The Federal Reserve started to tighten monetary policy in 2013 as the US economy was recovering from the financial crisis. The central bank gradually reduced its balance sheet and raised interest rates to prevent the economy from overheating.

As it stands now, Jerome Powell, chairman of the Federal Reserve, is currently in a balancing act between both monetary policies. Unfortunately, it seems like he’s trying to appease all sides. As I like to say, “sometimes doing the right thing is the hard thing.” In our opinion, a better decision would be to make these policies quick and painful upfront so that we would face a shorter run than what we're dealing with right now.

In short, we wouldn't be dealing with some lingering issues and continue to remain because he put a bandaid on our broken leg. 

Bottom Line

The actions of the Federal Reserve have a significant impact on everyday life and the economy as a whole. Through monetary policies such as quantitative easing and tightening, the Fed regulates the economy and affects things like inflation, interest rates, and the money supply. 

Knowing this, we can now speculate on their future actions and how they will affect the market. Be sure to tune into the latest episode for a deeper analysis of the Fed’s actions, what drives them, and what the future holds for the market.