Understand the Fed & Interest Rates

7.19.2016 | The Fed & Interest Rates – Rusty Tweed team

Why Does the Federal Reserve System Set Interest Rates?

In the same way that consumers and governments owe money to others, businesses also use debt to finance day-to-day expenses and long-term investments. Interest rates play a critical role in the success or failure of businesses. When interest rates increase, companies have less money to hand for more productive uses like investing and hiring. If there is a sudden increase, businesses may fail. For this reason, in countries like the U.S. that use a centralized banking model, the market and its laws of supply and demand do not randomly set interest rates. 

The Fed & Interest Rates - Rusty Tweed team

How Does the Federal Reserve Set Interest Rates?

The Federal Reserve System uses a variety of tools to set interest rates in order to control the country’s money supply and maintain economic stability. When inflation is rising, the Fed seeks to contract the money supply to cut it off. When the economy is struggling and unemployment is increasing, the Fed increases the supply of money. It does this to encourage companies to invest and consumers to spend.

Since retail banks tend to be the first financial institutions to expose money to the economy, they are the main instruments used by the central bank to manipulate the money supply. By adjusting the interest rates it lends to or borrows from the retail banks, the Fed can regulate the supply of money to the end user (individuals and companies).

Is the Fed Likely to Raise Interest Rates this Year?

According to CNBC, the Fed could surprise markets with at least one raise later this year. Fed funds futures anticipate a 40% chance of a rate hike this year. However, while economists agree that the Fed is taking the summer off, they do not otherwise agree on the timing. Rick Rieder, chief investment officer of global fixed income at BlackRock, believes, “the Fed would like to get a rate hike in and the question is are you going to get the opportunity to do it [balancing complex international and domestic issues], but I think the dynamics made it significantly more difficult.”

Reid predicts that if the Fed does increase interest rates this year, it will do it in December. He anticipates rates increasing then rather than during its September meeting, if Europe settles down and China looks more stable. 

References for The Fed & Interest Rates – Rusty Tweed team:





The Function of the Federal Reserve

7.18.2016 | The Function of the Federal Reserve – Rusty Tweed team

The Federal Reserve System, often referred to just as “the Fed”, is the central bank of the United States.

The Function of the Federal Reserve - Rusty Tweed team

What does the Fed do? Roger Lowenstein in his 2011 book, America’s Bank, describes the goal of the central bank as being “to keep the Monopoly game of our economy going so there’s enough money that people can invest and create companies and jobs and so on, and other people can get those jobs, but not so much money that the money becomes meaningless or worthless, something like paper confetti.” 

What does “the Fed” Do?

Today, the tools of the Federal Reserve fall into four main areas:

  • Executions of the U.S.’s monetary policy through influence over monetary supply and credit conditions with the  objective of full employment and stable pricing.
  • Supervision and regulation of banks and other critical financial institutions to protect the nation’s banking and financial system.
  • Maintenance of the financial system’s stability and therefore the containment of systemic risk that may occur in financial markets.
  • The provision of specific financial services to the U.S. government, U.S. financial institutions, and foreign official institutions.

The Federal Reserve is also a lender of last resort, as became evident in the 2008 financial crisis.

The Governance Structure of the Federal Reserve

The Board of Governors provides leadership for the System from Washington D.C.

The Board of Governors, also known as the Federal Reserve Board, is the national component of the Federal Reserve System. The board comprises of the seven governors, appointed by the president and confirmed by the Senate. To ensure stability and continuity, Governors serve 14-year, staggered terms. However, the chairman and vice-chairman serve four-year terms and may face reappointment subject to term limitations.

The Federal Open Market Committee (FMOC) meets eight times a year to determine the near-term direction of monetary policy and interest rates. The FOMC consists of seven governors of the Federal Reserve Board and five Federal Reserve Bank presidents.

Each Regional Reserve Bank has a board of 9 members. They implement monetary policy set by the Federal Reserve, thus take responsibility for member banks and commercial banks in their district.

References for The Function of the Federal Reserve – Rusty Tweed team:






America’s Bank, Roger Lowenstein

The Creation of the Federal Reserve System

7.17.2016 | The Creation of the Federal Reserve System – Rusty Tweed team

What factors led to the creation of the Federal Reserve System?

The Panic of 1907

In 1907, a host of factors converged to create “the Panic of 1907, the one that finally persuaded American lawmakers to deal with their country’s backward financial system”, according to Neil Irwin, author of The Alchemists: Three Central Bankers and a World on Fire.

A major earthquake in San Francisco in 1906 led insurers needing access to dollars at the same time, and the banks couldn’t provide them for weeks afterwards; coincided with it being a bumper year for crops, and an economic boom that led to many companies requiring significantly more cash than normal. A huge bank run ensued, the banking system went into crisis mode and the Panic of 1907 sparked one of the worst recessions in U.S. history.

The Need for a Centralized Banking System

The system, as it was, seized up. There were no central bodies from which the banks could take loans. Only a few wealthy bankers like J.P. Morgan, who would extend loans to other banks if possible when trouble loomed.

It was clear the U.S., by now a world power, needed a centralized system of control similar to the types of central banking that had existed in other countries for centuries, such as the Bank of England founded in 1694 or the Riksbank, the central Bank of Sweden, founded in 1668. Despite the immediate opposition, as now, to the idea of government playing a role in banking, 1908 saw the passing of the Aldrich Vreeland Act. The ideas behind the 1908 Act helped form the basis for the Federal Reserve Act signed by Woodrow Wilson in 1913.

The Creation of the Federal Reserve System - Rusty Tweed team

The men who led the newly created Federal Reserve banks, Dec. 23, 1913.
(Photo by Harris & Ewing)

The Creation of the Federal Reserve Board

The Federal Reserve Act aimed to promote maximum employment, fight inflation, and moderate long-term interest rates. In its creation, Congress sought to maintain the stability of the financial system. It also sought to contain systemic risk that may arise in financial markets. Banks and other important institutions became subject to supervision and regulation.

 Despite a great deal of opposition to the idea of centralization, the U.S. had at last its own central bank. New York supplanted London as the center of the global financial system. The dollar replaced the pound as the world’s leading currency.

References for The Creation of the Federal Reserve System – Rusty Tweed team:




When Genius Failed, Roger Lowenstein

The Alchemists, Neil Irwin


Trade Deficit Increased by 10% in May

7.9.2016 | Trade Deficit Increased by 10% – Rusty Tweed team

The U.S’ imports rose against its exports in May increasing by 1.6 percent to a seasonally adjusted $223.5 billion, the Commerce Department reported. The trade deficit increased to a three-month high of $41.1 billion in May – increased from a revised $37.4 billion in April, the government said this week.

U.S. Imports Increased

Higher demand for foreign imports included products as varied as home furnishings and cell phones. The rise in consumer imports indicates that Americans spent more in the second quarter after a slow start earlier in the year, adding to other recent signs of a stronger economy. Petroleum imports have also gone up. The cost of a barrel increased to its highest level yet this year.

Falling U.S. Exports

Against this, U.S. exports fell by 0.2 percent to $182.4 billion. The strong dollar combined with slowed economic growth worldwide accounts for falling export levels. Patrick Newport, an economist at IHS Global Insight, suggested that “the effects of the strong dollar and sluggish growth abroad will create headwinds over the next two years”.

However, it’s cheaper for Americans to buy foreign goods and/or to travel abroad. In spite of the increased trade gap, the deficit in the U.S. fell to its lowest levels from March to April since the beginning of 2014.

Changing Relationships

The trade gap with China rose by $1.7 billion to an adjusted $28.3 billion in May.

The U.S.’ relationship to the U.K. altered in May as a result of uncertainty running up to the vote over the European Union. American exports fell by $1.2 billion to $4 billion. Imports from the U.K. fell by $176 million to $4.3 billion.  There was a trade deficit of $324 million with the United Kingdom in May, a surprise shift following a $655 million surplus in April.

First reported in Market Watch