The Federal Reserve Bank: A Guide for Forex Traders

The United States Congress established the Federal Reserve System (the Fed), in 1913. The Fed's actions and policies have a major impact on currency value, affecting many trades involving the US Dollar. Find out about the history of the Fed, its influence on USD and how to trade Fed monetary policy decisions.

The Federal Reserve Bank: A Guide for Forex Traders

What is the FEDERAL REST?

The Federal Reserve is the central bank of the United States. It was established to ensure a stable and flexible financial system. It serves the public interest by overseeing effective economic operation and setting monetary policy.

The Fed has five functions that it performs to meet these high-level directives:

  1. Long-term, promote maximum employment, stable pricing, and moderate interest rates.
  2. To create a stable financial system, reduce risk wherever possible
  3. Financial institutions should provide safety
  4. Safety is the key to payment and settlement systems
  5. Promoting consumer protection via a supervisory stance

Each of the 12 Federal Reserve districts is responsible for carrying out day-to-day operations. Each Reserve Bank is an independent entity. The Federal Reserve Board of Governors supervises these member banks and districts.

Who is the Fed's owner?

The Fed can be both a public and private institution. While the Board of Governors can be considered a government agency and banks are private corporations, members of the Board of Governors have stock and receive dividends.

Who is the Federal Reserve Chairman?

Jerome Powell has been the Federal Reserve chairman since February 5, 2018, and he will be retiring in August 2019. The 16th person to hold the post is Powell, who will be serving a four year term. Prior to his appointment, Powell was a member of Board of Governors since May 25, 2012. He also currently serves as Chairman of the Federal Open Market Committee, which looks after monetary policy.

What banks are part of the Fed?

Each Federal Reserve District has its own Reserve Bank.

  • Boston
  • New York
  • Philadelphia
  • Cleveland
  • Richmond
  • Atlanta
  • Chicago
  • St. Louis
  • Minneapolis
  • Kansas
  • Dallas
  • San Francisco

How can the Fed be held responsible for its functions?

The Fed is both accountable to the US Congress and the public. Before Congress, the Chair and Federal Reserve officials testify. The system for setting monetary policy is meant to be transparent and clear. The Federal Open Market Committee (FOMC), in the interest of transparency, will publish statements after all annual meetings. To ensure financial accountability, all financial statements are independently audited once per year.

KEY ECONOMIC MODAL MANDATES FOR THE FEDERAL REST SYSTEM

The Federal Reserve Bank's core mandate is US monetary policy. The Congress has outlined the statutory goals of this monetary strategy and they are:

  • Maximum employment: The FOMC's monetary policy should ensure that unemployment stays low. It will also work to boost the economy wherever needed to help businesses thrive, profit, and hire more people to grow.
  • Price stability: Inflation rate of 2% over the long-term is what the Fed considers price stability.
  • Moderate long term interest rates: This is in conjunction with price stability. When an economy is stable long-term rates are at a moderate level

The Fed's goal is to influence interest rates and the financial environment in order to implement its monetary policy. This could lead to volatility in the US Dollar ahead of Fed announcements or changes to policies.

Federal Open Market Committee

The Federal Open Market Committee (FOMC) sets the monetary policy. It oversees open market operations at the Federal Reserve System. At FOMC meetings, they set a target federal funds rate. This is the interest rate banks should offer each other to get overnight loans. The FOMC can have three main influences on the rate.

  • Open market operations. This refers to the sale and purchase of government bonds on an open market. Selling bonds reduces the monetary supply in order to increase interest rates. With the goal of decreasing interest rates, money is put back into the economy by buying bonds.
  • Discount rate. This is the interest rate banks pay when they borrow money from the Fed. If this rate is lower than the Fed funds rate, it's more likely that the federal funds rate will also be lower.
  • Reserve requirements. Reserve requirements. Banks must hold a minimum percentage of customer deposits in order to cover withdrawals. If these levels are increased, banks cannot lend as much money and will have to ask for higher interest rates. Banks can borrow more money if interest rates are lower.

HOW DOES THE US DOLLAR FEEL ABOUT THE FEDERAL FUNDS RATE?

The Board of Governors of Federal Reserve System sets the Fed's interest rates, also known by the Fed funds rate. Both the current interest rate and future expectations can have an impact on the US Dollar's value. If traders anticipate an increase in interest rates, based on announcements by the Board of Governors this could cause the Dollar's value to appreciate or decrease against other currencies.

This table shows how market expectations and rate fluctuations can impact the dollar's value:

As you can see in the chart below, the Dollar strengthened against the Yen in the leadup to the Fed's interest rate announcement in December 2016 because it was widely expected that the fed funds rate would increase. On December 14, 2016, the pair reached a peak of 118.371 at the time.

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