The economy and the Fed

The economy is everybody

The economy is all the working, making, buying and selling in a country. When it's strong, people have jobs, shops are busy, and companies like Sunny Slice earn more. When it's weak, people lose jobs, spend less, and profits shrink. When the economy shrinks for a while, that's called a recession.

The Fed

The Federal Reserve, or "the Fed," is the central bank of the United States. You can think of it as the bank for the banks. Congress gave it two main jobs:

1. Jobs: help as many people as possible find work.
2. Steady prices: keep inflation low and steady. The Fed aims for about 2% a year.

Its main tool is the fed funds rate, the interest rate banks charge each other for overnight loans. When the Fed moves it, other rates (savings accounts, car loans, credit cards) tend to follow.

A thermostat for the economy

• Too hot: prices are rising fast. The Fed raises rates. Borrowing costs more, people and companies spend less, and inflation cools down.
• Too cold: people are losing jobs. The Fed cuts rates. Borrowing gets cheaper, and spending picks up.
• Just right: the Fed holds steady.

A real example: in 2022, inflation in the US hit about 9%, the highest in about 40 years. The Fed raised its rate from near 0% to over 5% by the middle of 2023, one of the fastest climbs in decades.

The reports everyone watches

• CPI, the Consumer Price Index. Every month it shows how much a basket of everyday things (food, rent, gas, haircuts) costs compared to a year ago. It's the inflation number you see in the news. (The Fed watches a similar measure called PCE most closely, but CPI moves markets a lot.)
• The jobs report. Usually out the first Friday of each month at 8:30 in the morning, New York time. It shows how many jobs were added and the unemployment rate.
• Fed meetings. The Fed's rate-setting group, the FOMC, meets 8 times a year. The decision comes out at 2 in the afternoon, New York time, and then the Fed's leader answers reporters' questions.
• GDP. Every three months, the total value of everything the country made. Two shrinking quarters in a row is a common rough sign of a recession, though the experts who officially call recessions look at more than that.

Surprises move markets

Just like with earnings, what matters is the surprise. If everyone expects inflation of 3.0% and CPI comes out at 3.4%, traders worry the Fed will keep rates high. Stocks and bonds can drop within minutes. If the Fed does exactly what everyone expected, the market may barely move.

Good news can be bad news

Here's a weird one. A super strong jobs report can make stocks fall. Why would good news hurt? Traders think: "The economy is hot, so the Fed will keep rates high." And a weak report can make stocks rise, because traders hope for rate cuts.

It depends on what the market is most worried about at the time: inflation or a recession.

Traders and investors

Many short-term traders avoid trading in the first minutes after these reports, because prices can jump wildly in both directions. Long-term investors mostly ignore the monthly noise and focus on businesses and decades.

Remember

• The Fed aims for lots of jobs and about 2% inflation.
• It raises rates to cool inflation and cuts rates to help a weak economy.
• CPI, the jobs report and Fed meetings are big market events.
• Markets move on surprises, and good news can be bad news.