Edmund Simms's avatar
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Fed watch • Credit creation, cause & effect • May 11, 2022
The Federal Reserve buys and sells securities and sets interest rates to influence: borrowing costs, lending activity, inflation and employment; to varying effects.

•••

Last week, the Fed added $1.5bn net to its Treasury security holdings and $5m net to its MBS holdings. The total amount of Reserve Bank credit increased by $869m net.
  • The 10-year Treasury yield dropped by 2bp to 2.91%.
  • The 30-year fixed-rate mortgage rose by 3bp to 5.30%.
  • The market expects the federal funds rate to hit 275-300bp by year-end. This rate was 300-325 last week.
  • The labour force participation rate and employment rate are dropping. This drop is happening while wages and rents are rising. Households are being squeezed but are meeting the difference with credit—consumer lending is exploding.

1/ The Federal Reserve buys and sells securities
sources: Federal Reserve Bank of St. Louis, Board of Governors of the Federal Reserve System

2/ And sets interest rates
source: CME Group Inc.

3/ To influence: borrowing costs
source: Federal Reserve Bank of St. Louis

4/ Lending activity
source: Federal Reserve Bank of St. Louis

5/ Inflation & employment
source: Federal Reserve Bank of St. Louis

6/ To varying effects
*the money multiplier is calculated as M2÷monetary base. The pre-GFC average (1958-2007) was 8.9. sources: Federal Reserve Bank of St. Louis, Valuabl

•••

ELI5: Why is this gobbledygook relevant?
The Federal Reserve creates money and uses it to buy bonds. They do this to push interest rates down and to put more money into the economy. Low rates mean people can borrow more, spend more, and afford higher prices. More spending and higher prices mean people feel rich, and businesses hire new employees.

But, if prices rise too quickly or people borrow too much, the Fed does the opposite. It sells the bonds it has and then destroys the money it receives. These sales push interest rates up and take money out of the economy. Higher rates mean people can't borrow or spend as much and need to pay lower prices. It makes people feel poorer than before, stops them from being able to spend as much, and makes businesses trim employment.

In addition to this, the Fed borrows and lends to banks. If a bank doesn't have enough money for a day or two, it can borrow from the Fed. If it has too much, it can lend to the Fed. A group of people who work for the Fed, the Federal Open Market Committee (FOMC), decide the interest rate that the Fed will pay for, or demand of, these short-term loans.

The Fed does these because they believe in two objectives: first, that a low and stable inflation rate is good for the economy, and second, that minimising unemployment is desirable.
Joey Hirendernath's avatar
New word of the day, "gobbledygook", hehe.

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