What Is "the Fed," and Why Does Wall Street Freak Out When It Talks?

Did you know there’s a group of people behind the scenes who can make your college loans more expensive, your savings account grow faster (or slower), how much you pay for a house, and even decide how much your favorite food costs at the grocery store?

They don’t work in Congress, they don't sit in the Oval Office. In fact they aren't even political. But their decisions affect everyone, including you.

They’re called the Federal Reserve, and they're pretty much the money lord of the U.S. However, the term "money lord" may be mean something different than what you expect. They don’t print money themselves (that’s the U.S. Mint), but they control something even more powerful: interest rates. An interest rate is the amount a lender charges a borrower, expressed as a percentage of the principal, which is the amount borrowed. By adjusting them, they can completely alter the circulation of money in the US, speeding up or slowing down the entire economy.

Wait, What Exactly Does the Fed Do?

The Federal Reserve (or “the Fed” for short) is the central bank of the U.S. That means they're the big dog that big banks like Bank of America and J.P. Morgan go to when they need to borrow money. In addition to loaning money to these banks, they determine how much it costs to borrow it by altering interest rates.

It was created in 1913 to do three big things:

1. Keep prices stable (so things don’t get way too expensive)

2. Help as many people as possible find jobs

3. Make sure the banking system doesn’t collapse

It’s made up of 12 regional banks, all led by the main branch in Washington, D.C. The person in charge of everything is called the Fed Chair. The Fed Chair is a super important economist (currently a man named Jerome Powell) who's pretty much the captain of the ship.

Why Are Interest Rates So Influential?

Every year, the Fed targets a 2% inflation rate. This is a good, balanced, spot: high enough to encourage spending and investing, while also keeping prices stable enough to avoid hurting consumers.

If prices are rising too quickly, the Fed will raise interest rates. What that does is make it more expensive to borrow money (because borrowers pay more interest), therefore causing people and businesses to slow down spending.

Most big spending in an economy comes through borrowing, so this is pretty significant. Consumers like me or you take out a loans for our biggest purchases (houses and a cars), just as businesses will borrow money for their most extreme operations expansion projects (ex. build a new factory).

Put yourselves in the shoes of a person or business: would you borrow money when rates are high or wait until they're lower? Probably the latter.

How Does the Fed Impact the Stock Market?

You might not think the Federal Reserve has anything to do with the stock market, but Wall Street watches the Fed like a hawk.

Here’s why:

As I explained earlier, when the Fed raises interest rates, borrowing money gets more expensive. Remember, that slows down spending by both businesses and consumers, which usually means companies won't be coming out with as many new products, and consumers won't be buying as many existing ones. At the end of the day, that leads to lower profits.

On the flip side, when the Fed lowers interest rates, it’s cheaper to borrow and easier to grow. People spend more, businesses invest more, and profits go up. Stock prices often follow suit.

Think of it like this: higher rates = harder to grow, lower rates = easier to grow.

That’s why you’ll often hear things like “stocks fall after Fed rate hike” or “market rallies on Fed announcement.” Investors are constantly trying to guess what the Fed will do next to beat the rest of the pack.

What Makes Being the Fed Chair So Difficult?

To end off this article and answer this final question, I'll give you a scenario where you get to be the Fed Chair. Let’s say inflation is getting out of control, people are complaining as prices rise, and the news is going crazy. You have a choice:

1. Raise interest rates to slow things down, risking causing a recession

2. Keep rates low, risking making inflation worse

What would you do?