The Federal Reserve is the central bank of the United States of America, and is tasked with overseeing monetary policy and regulating the financial system.
Purpose of the Federal Reserve
The Federal Reserve has 5 main duties: conducting monetary policy, regulating banks, monitoring and protecting consumers’ credit rights, providing financial services to the federal government and maintaining the stability of the financial system.
Federal Reserve Structure
The federal reserve is composed of a board of governors, 12 regional Federal Reserve banks and a bureaucratic agency located in Washington, D.C.
It is important to note that the Federal Reserve is composed of publicly-appointed officials, private banking members and professional bureaucrats.
Federal Reserve and Monetary Policy
While the Federal Reserve’s regulation of the financial industry is often newsworthy and important, it is its conduct of monetary policy that draws the most attention by far.
The Federal Reserve sets interest rates, by conducting monetary policy, that have a strong influence on the economic performance and inflation rate of the country. The Federal Reserve has a ‘dual-mandate’ to maintain full employment while keeping the rate of inflation around 2% per year.
Because the Federal Reserve’s monetary policy actions are so important to financial assets in the United States and around the world, the words and actions of key Federal Reserve members are watched closely by financial professionals.
Federal Reserve and Trading
Regardless of a day trader’s trading strategy or choice of asset class, they should develop the habit of tracking the monetary policy activity and commentary of the key figures in the Federal Reserve.
While United States government bonds and currency pairs are particularly influenced by the Federal Reserve, this impact spreads to all areas of the market, including corporate bonds and equity indices to a significant extent.
Federal Reserve announcements are not only important in a broad sense, but also offer significant actionable trading opportunities. Major policy announcements can move bond prices, equity indices and currency pairs more than 1% in a day, which represents substantial market moves by any standard.
Furthermore, the reactions to Federal Reserve activity are not always uniformly clear and linear, and can often create substantial volatility in a number of different market areas.
That said, Federal Reserve activity is closely monitored, and direct policy actions and official announcements are often accurately forecast long in advance.
This can create a common ‘sell the news’ effect from Federal Reserve activity, where long-forecast actions have already been priced into the market, and their actual manifestation leads to little or even counter-intuitive price action.
Day traders looking to create trades based on actionable Federal Reserve activity are highly encouraged to practice with a number of Federal Reserve events before trading with real money, to get a solid grasp on the kind of price action that they create.
Final Thoughts
As the central bank of the largest economy in the world, the Federal Reserve is central to much of the every day global activity that takes place.
Monitoring Federal Reserve activity can offer day traders a wide range of actionable trading opportunities, and even day traders who do not intend to trade directly should monitor Federal Reserve activity nonetheless so that they stay abreast of its influence on nearly every asset class around the world.