The full meaning of FED is “Federal Reserve System.” FED plays a very important role in the Forex industry. It is one of the crucial banking systems in the US. It regulates both the United States and the global economy inclusive.The United States’s Central Bank is responsible for managing the country’s monetary policy, which has an impact on inflation and interest rates. Every Forex trader is meant to understand the actions of FED in the industry because it always comes with a high impact on the value of currencies globally, especially the currencies that pair with the US Dollar.In this article, I will be giving a detailed explanation on the roles of FED, how it affects the Forex market, and the best method to approach it as a good trader to make some profits out of it.
Overview and Brief History Of Federal Reserve and Its Impact on the Global Economy
The Federal Reserve or FED, was created in 1913. It is the central bank of the United States, created for the purpose of stabilizing the US financial sector by preventing financial crises and also to reduce inflation in the US economy.
As far back as 1944, after World War II, the US dollar was made the global currency, and other currencies were all linked to it. This agreement was popularly known as the Bretton Woods agreement. This leads to the central bank of different countries holding the US dollar and also engaging it in forex trading with the sole purpose of stabilizing their own different currencies. Here, dollars were tied to gold at the rate of $33 per ounce. This Bretton Woods agreement made FED a key player in international Forex trading.
In 1971, President Richard Nixon untied the dollar from gold, which made currency value to float because of supply and demand, and this brought about a new system where the value of currencies is determined by the market force instead of being tied to gold. Now traders all over the world are now watching and monitoring the FED announcement because of its impact on USD and other currencies that have been paired with it.
The FED has played a good role in this 21st century, ranging from 2008, when there was a financial crisis, and the FED decided to implement quantitative easing (QE), which caused an inflow of liquidity, thereby decreasing the value of dollars. This action stimulated the economy by making other currencies appreciate against the US dollar.
In 2020, during COVID-19, the FED reduced the interest rate to almost zero and also implemented quantitative easing (QE) to be able to stabilize the US economy and also make other currencies appreciate over the US dollar.
WHAT ARE THE FUNCTION OF FED IN THE FOREX MARKET?
- In the Forex trading industry, the FED plays a very important role in US interest rates. It achieves this by making a monetary policy that can either increase or decrease the value of the dollar. If the Fed decides to increase the interest rate or hold it still, it will make the US Dollar appreciate in value, but if they decide to decrease it, the value of the US Dollar will reduce, which will definitely scare investors away.
- FED also works tirelessly to reduce inflation in the economy; they achieve this by increasing or reducing the interest rate. Each time FED notices inflation in the economy, they tend to increase the interest rate, which helps to balance everything. But if inflation is going down, the FED will reduce the interest rate, which will affect the value of the US dollar by making it weaker.
- FED has an important role to perform when it comes to regulating the employment rate on the labour market. When interest rates are lowered, investors and businesses will expand, thereby employing more people into the labour force, but when the interest rate is increased, businesses will strive to survive, they will reduce the number of their employees, and this will reduce the employment rate.
- Sometimes FED enters the open market operations by buying and selling government securities; this operation aids in controlling money supply. Buying government securities leads to an inflow of money into the economy; these can cause a decrease in the value of dollar. But if FED decides to sell the securities, it will increase the value of the dollar.
- Monthly or biweekly, the FED always makes announcements. This announcement always makes changes in the Forex market. Traders and those who trade fundamentals always study this FED announcement and take advantage of the market volatility to make some profits if their analysis and predictions are right.
HOW DOES THE FED POLICY AFFECT THE ECONOMY?
- FED regulates the economy by making sure that the interest rates and the money being lent by banks are well regulated. They achieve this by making sure that the interest rate is not too high so that investors, companies, and individuals can get the loan, establish and afford what they wish to afford, and repay the loan at ease. But if the interest rate is hiked by FED, it will definitely scare away companies, institutions, and individuals who wish to get a loan for investment. This is how FED slows down a booming economy.
- Just as I have said above, FED helps in controlling inflation in the economy by maintaining the stability of prices. They increased the interest rate to reduce excessive spending and excessive money supply in the economy, which tends to make the circulation of money stable. Because if they make some policies that are too hash, it is likely to take the whole country into recession, at the same time, if they make a policy that is too lenient, it will affect the purchasing power of consumers, thereby making the economy unstable.
- During times of crisis, the FED increases the inflow of liquidity into the financial markets. This action boosts the confidence of investors and companies to invest in any projects of their choice in the country.
HOW DOES FED AFFECT THE GLOBAL MARKET?
- FED helps to tighten the global economic and financial conditions; they can achieve this by increasing the interest rate, which makes borrowing very difficult, thereby reducing the rate at which people spend and invest money globally.
- There are several countries that generate their revenue by exporting their goods or services. If FED makes a decision that increases the value of the US dollar, it will definitely lead to a decrease in the value of the currencies that do transactions or business with the US dollar by reducing the demand for their goods and services, which will definitely affect such countries economies.
- If we should take our time to observe, we will notice that each time FED tightens their policy to reduce inflation, other countries, through their central banks, will definitely go ahead to tighten theirs. Especially if this country makes transactions and business with the US Dollar. They do this to protect their own currency and economy from inflation.
- In Africa, Nigeria is one of the major producers and exporters of oil, while Ghana is one of the major producers and exporters of gold. If the FED makes a policy that makes the US Dollar stronger, it will affect these commodities by making them expensive for other countries with weaker currencies, leading to a drastic drop in the demand of these commodities globally. Exporters may have no other option than to reduce the price of their commodities in order to make sales. This policy will affect the exporters economy and also prevent them from achieving their schedule budget after sales
- There are so many underdeveloped countries that rely on foreign investors to attain some growth. If the FED decides to increase the interest rate, investors may find it difficult to get loans to invest in these countries, thereby affecting their economic growth. But if FED makes the interest rate favorable by reducing it, these companies and investors can establish themselves in these underdeveloped countries and also help to boost their economies.
CONCLUSION
The Federal Reserve (FED) has this sole purpose of regulating, shaping, and maintaining the US economy, which has some impact on the global financial economy, especially countries that trade with the US Dollar.Just as I’ve discussed above, they achieve this economic stabilization by regulating monetary policy, employment rates, interest rates, etc.As a Forex trader, it is important to pay close attention to this Federal Reserve policy and the decisions they always make because they always play a very important role in the volatility of the market.