Anahit

This visualisation shows the relationship between the federal funds rate and the S&P500 index as an example. The chart clearly shows that there is a strong relationship between the Fed funds rate and how the stock market is trending. Other asset classes or interest rates for other countries could be used to draw similar comparisons. The federal funds rate is the interest rate at which banks trade money with each other overnight. When a bank has extra money, it can lend to another bank that needs it. This is determined by the two banks involved and is called the effective federal funds rate. It is a weighted average rate of all such types of transactions. The effective federal funds rate is essentially determined by the market but is influenced by the Federal Reserve through open market operations to reach the federal funds rate target. The Federal Reserve influences the effective federal funds rate by buying or selling government bonds. If they sell bonds, there is less money available, and the federal funds rate goes up. If they buy bonds, there is more money available, and the federal funds rate goes down. The Federal Reserve does this to control the economy. The Federal Open Market Committee (FOMC) meets regularly to decide on the federal funds target rate. They consider factors like inflation, employment, consumer spending, and business investments. If the economy is growing too fast, they may raise the federal funds rate to slow it down. If the economy needs a boost, they may lower the rate. The federal funds rate is important because it affects other interest rates in the financial market. It can influence rates on loans, mortgages, and savings, which are important for consumers. It also indirectly affects the prime rate, which banks charge customers with good credit. Overall, the federal funds rate is a key tool used by the Federal Reserve to manage the economy and has an impact on various aspects of financial transactions and consumer confidence. Key Takeaways An increase in Fed funds rate spooks the stock market as the return from investing in the stock market becomes lower as compared to investing in the bank. As shown in the chart, the federal reserve bank has the power to stimulate the economy by lowering the rates or slow down the economy by increasing the rates. Contrary to common understanding, the stock market normally trends downward when the federal reserve starts to pivot or reduce the rates. These time periods have also corresponded with the financial distress in the economy or when some part of the economy breaks beyond the repair.

CREATE A FREE ACCOUNT TO CONTINUE

🎉 Strategy Complete! 🎉