Fed Terminology 101

by | 26 Feb, 2019

 

The US Federal Reserve has had always had an incredibly important role to play in global markets, but how do you cut through all of the jargon and get to the meat of what’s going on?

If any of you have done economics at school or university, then you’ll be familiar with the monetary policy and the role of the central bank in the economy. If not, then today is your lucky day because understanding what the Fed is doing will undoubtedly help your investments!

 

Breaking through the Jargon

If you’ve watched or read about announcements from central banks then you would have seen the terms ‘dovish’ and ‘hawkish’ thrown about in conversation. Now while economics can be somewhat of a zoo at times, these are not referring to real animals. Both terms describe forms of monetary policy, the first expansionary and the latter contractionary. But we’ll get back to that once we’ve established what Central Banks are actually responsible for.

The central bank itself is tasked with keeping with keeping inflation in a manageable range so that prices do not get out of control and that the country grows at a sustainable rate. It achieves this by using its favourite tool – interest rates.

Interest rates should be a familiar concept because if you’ve ever taken out a loan then you would know that the interest rate is the price you pay for borrowing money. The central bank uses interest rates as part of its monetary policy to control the amount of money circulating in the economy. Too much money in the system causes inflation, but too little money cripples growth.The central bank tries to find a happy medium between the two by increasing and decreasing interest rates to find the optimal level for the economy.

 

What are the effects?

Increasing interest rates makes money more expensive to borrow or hold which reduces loan-holders’ disposable income and disincentivises more people from seeking loans at the new, higher prices. Higher interest rates also means that bonds become more valuable and the opportunity cost of holding cash increases, making people happier to stick their money in the bank to earn a better rate on it instead of spending it. This sucks money out of the system, slowing consumption and subduing growth when things are moving too fast. The central bank is said to be ‘hawkish’ when it increases rates because a hawk is known for its aggression, speed and and harshness which can be likened to an increase in the cost of borrowing.

Decreasing interest rates does the opposite by making money cheaper to borrow. This induces people to spend and consume more which in turn drives growth by injecting money into the system when things are moving too slowly. Lower interest rates also means that bonds become less attractive and the opportunity cost of holding cash decreases, making people more likely to spend it than put it in the bank.The central bank is said to be dovish when it decreases rates because doves are generally seen as a sign of peace and tranquility which can be compared to the feeling of ease when the costs of borrowing are lower.

 

What happens in the markets?

In general, a decrease in interest rates is good for stocks. Consumers have more disposable income to invest in the markets and spend in stores. Companies also have greater access to loans for development capital which in turn helps them grow more. The opposite holds for an increase in rates.

In the currency market an increase in rates makes that country’s currency appreciate in value as foreign investors buy its higher interest rate bonds. This in turn boosts the currency as foreign investors must change their currency into domestic currency to buy the bonds.

A shift in monetary policy affects the whole country and sometimes even the entire global economy. Given that many countries hold debt denominated in dollars, a change in monetary policy in the US will affect any country that holds debt in two ways.

1) The cost of holding debt (interest rate) is higher, making repayments more expensive.

2) The dollar appreciates which makes the debt more expensive in that country’s domestic currency.

It’s a scary double whammy which hurts the most indebted and currency sensitive countries the most which tends to be emerging markets. 2018 was a great example of the power of higher interest rates to squeeze growth in emerging markets which fell considerable towards the end of 2018 as the Fed tightened its rates, then came back when it put the rate hike cycle on pause.

 

What’s the Moral of the Story?

Understanding the Fed and central bank jargon is extremely important as an investor because the slightest change could impact your portfolio considerably. So, when the Fed speaks you listen!

 

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Oil's Slick Upward Move

Technocratic officialdom just declared UBS, Zurich Insurance, Nestle, and in fact, the entire Swiss stock exchange, 'off-limits.' They've done what, now?

Once upon a time, a complex myriad of red tape allowed Swiss stocks to be traded across the European Union (EU). Brussels said enough's enough to that and decided to craft one deal to rule them all. While that was being drafted, a Swiss subplot started to boil. Elections, euro-skepticism, and trade unionists became a focal point, and the EU's immovable deal hit a Switzerland's unstoppable sentiment. The treaty crumpled.

In short, the EU just sent the bloc's fourth-largest exchange packing. The SIX, valued at $1.7 trillion with Nestle and Novartis on its register, is out it's own bounds. We can't invest in it anymore!

It's hard to tell who has this worst. For a start, Swiss companies may be forced to other stock exchanges outside Switzerland. A few already have. Investors still with access could end up paying more for shares as, with a European third of orders gone, brokers recoup money by setting higher asking prices. And the officials behind all this? Truly at each other's throats. 

Within the political mire, many hoped both sides could iron out their differences and keep the "equivalence" agreement going. Nope. Switzerland is furious with the EU for what it sees as a flex of power in front of Britain, still in its Brexit muddle. Creating a theatre, it sounds like Brussels is shouting 'don't mess with us!' in the direction of the UK, now teetering closer to a no-deal cliff edge. As Brussels endures its own leadership merry-go-round, Downing Street doesn’t even know to whom it should address its strongly worded letters…

All this couldn't happen to British stocks, could it? Could it?!

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This communication is not an offer or solicitation to purchase or sell securities. Investing in securities carries risk, including the loss of principal. Past performance is not indicative of future returns, which may vary. Online trading has inherent risk due to system response and access times that may be affected by various factors, including but not limited to market conditions and system performance. An investor should understand such facts before trading. The risks associated with investing in international securities, including US-listed ADRs and ETFs that contain non-US securities include, among others, country/political risk relating to the government in the home country; exchange rate risk if the country's currency is devalued; and inflationary/purchasing power risks if the currency of the home country becomes less valuable as the general level of prices for goods and services rises. Before investing in an ETF, an investor should consider the investment objectives, risks, charges, and expense of the investment company carefully. ETF prospectuses are accessible within the mobile application via a link under each company’s “Description.”

A fractional share is a share of equity ownership that is less than one full share. Fractional share investing has certain limitations and restrictions that investors should understand prior to purchasing fractional shares: ownership of less than one full share does not give the fractional share owner the right to vote on company matters; fractional shares are non-transferrable, meaning they cannot be transferred to another brokerage firm; and fractional share orders will be accepted as market orders only. For more information and details on fractional shares, and any associated limitations or restrictions please visit: https://drivewealth.com/fractional-shares-disclosure

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ALL RIGHTS RESERVED © INVSTR LTD. 2018

Risk Disclosure:

Invstr is a technology platform, not a registered broker-dealer or investment adviser. Invstr does not offer its own recommendations of any security or provide its own research to any user regarding any security transaction or order.

Please note, investing involves risk and investments may lose value. Past performance does not guarantee future results.

Brokerage services of US-traded securities, including fractional trading, are provided to Invstr users by DriveWealth, LLC a registered broker-dealer and member of FINRA/SIPC. DriveWealth may not establish investment accounts to residents of certain jurisdictions. 

DriveWealth provides no tax, legal, or investment advice of any kind, nor does DriveWealth give advice or offer opinions with respect to the nature, potential value, or suitability of any securities transaction or investment strategy. DriveWealth acts as the clearing firm for securities transactions entered on the Invstr mobile platform. DriveWealth is not affiliated with Invstr. Invstr does not participate in DriveWealth’s decision-making.

There is no minimum initial deposit required to open an investing account with DriveWealth. Expenses and Fees associated with the DriveWealth platform in conjunction with Beanstox includes either a monthly membership fee of $4.99 with a commission charge of $0.01 per share* or, in the event the membership fee is not paid, a commission charge of $0.0125 per share applies, subject to a minimum of $2.99 per transaction. There are no monthly minimum fees, or required ongoing minimum account balance. For non-resident aliens, there is a one-time tax verification fee of $5.00 (representing Form W-8BEN pass-through processing cost). View a full list of our fees at http://bit.ly/DWFees

The monthly subscription charge is four dollars and ninety-nine cents (US$4.99) per month plus one cent (US$0.01) per share traded (as examples, for a Transaction of 0.90 shares, the per share traded charge is one cent (US$0.01), and for a Transaction of 1.6 shares, the per share traded charge would be two cents ($0.02), and the quarterly subscription charge is fourteen dollars and ninety-nine cents (US$14.97) every 3 months plus one cent (US$0.01) per share traded. The monthly and quarterly subscription charges may be greater or less depending on additional services offered by a DriveWealth partners as part of the subscription model offering, or based on any subsidies provided by a DriveWealth partner as part of the subscription model offering. For non-resident aliens, there is a one-time tax verification fee of $5.00 (representing Form W-8BEN pass-through processing cost).View a full list of our fees at http://bit.ly/DWFees

This communication is not an offer or solicitation to purchase or sell securities. Investing in securities carries risk, including the loss of principal. Past performance is not indicative of future returns, which may vary. Online trading has inherent risk due to system response and access times that may be affected by various factors, including but not limited to market conditions and system performance. An investor should understand such facts before trading. The risks associated with investing in international securities, including US-listed ADRs and ETFs that contain non-US securities include, among others, country/political risk relating to the government in the home country; exchange rate risk if the country's currency is devalued; and inflationary/purchasing power risks if the currency of the home country becomes less valuable as the general level of prices for goods and services rises. Before investing in an ETF, an investor should consider the investment objectives, risks, charges, and expense of the investment company carefully. ETF prospectuses are accessible within the mobile application via a link under each company’s “Description.”

A fractional share is a share of equity ownership that is less than one full share. Fractional share investing has certain limitations and restrictions that investors should understand prior to purchasing fractional shares: ownership of less than one full share does not give the fractional share owner the right to vote on company matters; fractional shares are non-transferrable, meaning they cannot be transferred to another brokerage firm; and fractional share orders will be accepted as market orders only. For more information and details on fractional shares, and any associated limitations or restrictions please visit: https://drivewealth.com/fractional-shares-disclosure

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