The Federal Reserve sets interest rates for the world’s biggest economy, and its decisions ripple all the way to Australian shares, the dollar and mortgages.
The Federal Reserve, often called “the Fed”, is the central bank of the United States.
Like the Reserve Bank of Australia, its best-known job is setting interest rates. But because the U.S. economy is the largest in the world and the U.S. dollar is used in so much global trade and borrowing, the Fed’s decisions are watched far beyond America.
Interest rate decisions are made by the Federal Open Market Committee, or FOMC. It has 12 voting members: the seven governors of the Federal Reserve Board in Washington, the president of the New York Federal Reserve Bank, and four of the other 11 regional Federal Reserve Bank presidents, who take turns to vote. The Fed’s chair leads both the Board and the committee.
The FOMC holds eight scheduled meetings a year. At each one, it sets a target range for the federal funds rate, the rate at which U.S. banks lend to each other overnight. It’s the American equivalent of Australia’s cash rate.
Congress has given the Fed two goals, often called its dual mandate: maximum employment and stable prices. The Fed defines stable prices as inflation of 2 per cent over time.
Why a Fed decision reaches Australia
When the Fed changes rates, the effects travel quickly through global markets.
Higher U.S. rates tend to make the U.S. dollar more attractive to investors, which can push the Australian dollar lower. Lower U.S. rates often do the opposite. A weaker Australian dollar makes imports and overseas travel more expensive, but helps exporters.
Fed decisions also move sharemarkets. Wall Street often reacts within minutes of an announcement, and the Australian sharemarket tends to follow when it opens. Because many Australians’ superannuation funds hold large investments in U.S. shares, those moves flow through to retirement savings too.
The Fed also influences borrowing costs around the world, which can feed into what Australian banks pay for funding from overseas markets.
That doesn’t mean the Reserve Bank of Australia simply follows the Fed. The RBA sets rates based on conditions in Australia, and the two have often moved at different times and speeds. But the Fed shapes the global backdrop the RBA works within.
Markets pay as much attention to what the Fed says as to what it does. Each decision comes with a statement, and the chair then holds a press conference, where every word is parsed for clues about the next move.
