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Five things to know about the U.S. Federal reserve bank

The U.S. Federal Reserve bank is undoubtedly the most powerful central bank in the world. This comes due to the fact that the Fed oversees the monetary policy that directly impacts the U.S. dollar. The USD, as you would know is the world’s reserve currency.

Nearly 90% of all global transactions are done in the U.S. dollar, including many economies borrowing in the U.S. dollar currency. Therefore, the Federal Reserve wields immense power over the currency, also known as the greenback.

For forex traders, the actions from the Federal reserve bank has a profound impact as well. This is because, most of the currencies are quoted against the U.S dollar. Therefore, prices can be heavily influenced by actions from the Federal Reserve.

Some traders also come up possible trading strategies that revolve around the Federal Reserve. As a trader, it is therefore important that you are well acquainted with the Federal Reserve. Here are a few things that you should know about the Federal Reserve Bank, also known as the Fed.

1. What is the Fed’s open market committee composed of?

Short term interest rates are decided by the Federal Reserve committee. It is called the Federal Reserve Open Markets Committee, or FOMC for short. There are a total of twelve members that make up the FOMC. These include seven members from the board of governors.

The governor of the New York Fed also holds a permanent position. The remaining four members are the governors from one of the twelve regional Federal Reserve banks. These governors hold the FOMC committee for a year and are rotated.

The President of the Federal reserve bank is appointed by the U.S. President and is confirmed by the Senate.

2. How does the Fed set up monetary policy

The FOMC meets eight times a year which are scheduled and also published on the Fed’s website. The FOMC sets the interest rates by tweaking the money supply. It also has a number of rates at its disposal to influence the short term interest rates.

Long term interest rates are set up by the markets. Thus, the Fed does not have a direct influence on the long term rates. It can only adjust the short term rates. However, this influence has ripple effects over longer rates as well.

Members of the FOMC can vote at the meetings on whether they want to raise rates, leave rates unchanged or cut rates. Each of the twelve members of the FOMC has a vote. A consensus is built accordingly. Members who vote against the consensus are called dissenters.

When the Fed sets rates, it also publishes the names of the FOMC members who voted for and against the consensus.

3. Types of rates that are determined by the Fed

The Fed targets three kinds of interest rates, which are explained as below:

Target Federal Funds Rate "Fed Funds": Rate at which banks lend or borrow among themselves on an unsecured basis. money still held at the Fed to maintain reserve requirements. FOMC sets a range for this rate but the actual rate is calculated from data.

Discount rate: (Primary credit/secondary credit/seasonal rates): Rate charged by the Fed when lending funds to members to deal with short term shortages of liquidity on a collateralized basis. Discount rate is about 50% bps (primary credit) and 100 bps (secondary, seasonal credit). Discount rate is higher than the Fed funds target rate. Both primary and secondary are short term.

IORR/IOER (Interest on Required Reserve balances/Interest on excess balances): Types of interest that the Fed pays on required/excess reserve balances held at the Fed. introduced after the global financial crisis. The IORR and IOER helps to stabilize other monetary instruments.

4. The Hawks and the Doves

Hawks and doves are monikers used in the central banking circles. Just as you have bulls and bearish in the markets, where the bulls represent those who expect prices to rise and bears who expect prices to fall, hawks and doves represent the same thing.

The major difference here being that a hawk is a moniker given to a central bank governor who is supportive of higher interest rates. Meanwhile, dove is a moniker given to a central bank governor who is supportive of lower interest rates.

The FOMC meeting is basically a battle between the hawks and the doves.

5. The FOMC statement and meeting minutes

The Fed meeting typically starts on a Tuesday and concludes on Wednesday. The Fed publishes the monetary policy statement, known as the FOMC statement, which summarizes the Fed’s view on the economy.

Investors scrutinize the FOMC statement on a word by word basis. They also compare the latest FOMC statement to the previous Fed statement to see if there are any major changes. Each of these can play a big role in the FX markets and also influences the bond or fixed income and the equity markets.

Three weeks after the FOMC meeting, the Fed publishes the FOMC meeting minutes. This is more detailed and also shows the various deliberations of each of the twelve policy makers of the Fed.

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