5 THINGS TO KNOW ABOUT THE FEDERAL RATE HIKE

Explaining the upcoming Federal Rate Hike is a bit complicated, but here we go—this is a glossary of all the important terms to remember, so if you get lost, just refer back to them:

INVOLVED PARTIES

“Depository institutions”: US banks and credit unions.

“US Federal Reserve”: Place where all depository institutions keep their reserve balances.

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MONETARY TERMS

“Reserve balance”: the monetary amount the US Federal Reserve requires a depository institution to keep in reserve

“Surplus balance”: the monetary amount held by a depository institution, kept in the US Federal Reserve, that exceeds their minimum reserve balance

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LOAN TERMS

“Collateral”: amount given to a lender for them to keep, should the borrower become unable to repay the loan.

“Interest rate”: a certain percentage of a loan the lender charges the borrower, at given intervals, until the borrower fully repays the loan. 

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WHAT IS THE FEDERAL RATE?

The federal rate is a very important factor in world financial markets. In summary, the federal rate is the interest rate at which depository institutions lend their reserve balances to other depository institutions, on an overnight basis, without requiring collateral.

The loans are made by institutions with surplus balances in their accounts, to institutions are in need of money to maintain their reserve balances. The loans that depository institutions make come from their surplus balance.

The interest rate that the borrowing institution pays to the lending institution is negotiated between the two institutions. The average of this rate across all such loans in the US is called the “federal funds effective rate.”

A group called the “Federal Open Market Committee” meets eight times a year to determine the “federal funds target rate”, which is the ideal version of the “federal funds effective rate.” The group may also schedule additional meetings if the effective rate slides too far from the target rate.

In order to best keep these rates in line with each other (and in doing so, keep the US economy stable), the Federal Reserve ultimately controls the overall supply of money that enters the economy.

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HIGHER RATES MEAN BETTER ECONOMY

On Wednesday, the Federal Reserve is expected to announce a rate hike, which is good— rate hikes indicate the economy is doing well, meaning jobs are being added, wages are growing, and unemployment is low. This will be the second time since December of 2016 that the Federal Reserve, called the “Fed” for short, has performed a rate hike.

In 2008, after the housing market collapsed and the Great Recession began, the Fed placed interest rates at 0% to help the market recover. Thankfully, America is no longer facing any economic crises, so higher interest rates to help the economy grow further are acceptable. In fact, things are looking so good that the Fed is expected to raise rates three times this year, as opposed to one raise each year over the past two years. On a whole however, the current rates are still generally low, when compared to the rates of the past 100 years.

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IT'S A DOT PLOT

The specific amount of Wednesday’s expected rate hike is sure to be a big headline, but the most anticipated reveal will be the Fed's "dot plot", a projection chart showing how many times the Fed expects to raise rates this year, as well as in years to come. The last dot plot was released in December 2016.

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AN END TO DODD/FRANK?

In an attempt to further shape the economy, Trump recently announced his plans to remove Dodd-Frank, a financial regulation that was created after the Great Recession in order to prevent Wall Street banks from engaging in risky lending. Trump sees the policy as more of a burden on the economy than a safeguard. Fed Chair Janet Yellen doesn’t agree, and will hold a press conference after Wednesday’s hike announcement, during which she is expected to further push back against Trump’s plans to remove Dodd-Frank.

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IS YELLEN DONE?

President Trump has been an extremely vocal critic of Janet Yellen, and considering that her term of office ends in January 2018, and that Trump appoints all Fed members, we may be witnessing the end of the “Yellen Fed”. Two additional key positions at the Fed will open up in 2018 (including the position of second-in-line Stanley Fischer), giving Trump the power to instantly reshape the Fed’s leadership team. Steven Mnuchin, Trump’s newly appointed treasury secretary, has been less critical of Yellen and the Fed, but still, heavy leadership changes at the Fed seem to be on the horizon.