Explaining the Fed's Mandate

Martin R
Category:  Trading Articles
If there’s one influential central bank in the world, that’s the Federal Reserve of the United States. The Fed, as it is also called, sets the key interest rate level, or the federal funds rate, on the world’s reserve currency: the USD.
Setting the monetary policy on the world’s reserve currency is no easy task. In fact, it is a tremendous responsibility that the Fed has as most nations around the world keep their reserves in USD.
So, when the Fed decides to raise or to lower the interest rate, the entire world pays attention. Financial markets usually react the first. And, the first reaction is always an impulsive one. Hence, the strongest.
Next, a new macro-trend builds as the financial system digests the Fed’s decisions.
When interpreting the Fed’s monetary policy, we must make a distinction. That is, between a rate hike and a tightening cycle. Or, a rate cut and an easing cycle.
A singular hike or cut has temporary effects. Usually, it corrects some wrong decisions from the past.
A cycle shows determination. It confirms an economic state and conditions there to stay.

What Matters for the Fed

The Fed, like any other central bank in the world, has a mandate. It safeguards price stability.
In economic terms, inflation determines the stability of prices. Namely, higher inflation shows the price of all goods and services increased. Lower inflation, on the other hand, shows a decrease in prices over a determined period.
Price stability has a value. In capitalistic economies, prices are considered “stable” when inflation stays around two percent.
Levels below but close to two percent are normal for an economy to grow naturally. Hence, to trigger a response from the Fed, inflation must deviate from the target.
That’s the first part of the Fed’s mandate: to safeguard price stability. While most of the other central banks in the world only focus on inflation (price stability), the Fed has a dual mandate.
Besides inflation, the Fed is in charge with job creation. Or, to stimulate the American economy to create jobs.
Not only it looks an inflation, but also at jobs creation. Suddenly, jobs data in the United States becomes vital not only for the Fed and the American economy but also for the entire world, due to the USD’s role as a world’s reserve currency.

Conclusion

Forex traders try to anticipate the central bankers’ moves. They interpret economic data and position their portfolios accordingly, by buying and selling currency pairs.
The Fed’s monetary policy decisions tops of the list of precious information to keep an eye on. Everything else becomes secondary.
 
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