The US Federal Reserve has been aggressively raising the Fed Funds Rate. In this video, I will be explaining how their actions are going to crush the economy.
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Fed Funds Rate:
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I wanted to make a video to explain how the Fed Rates impact the economy from a practical perspective. Everyone knows there is inflation. Everyone knows the Fed has been raising rates. But what does that really mean? From a practical perspective, there are actual decisions being made in board rooms that are going to impact your life.
Let us start with what has happened. When we look at the Fed Funds rate it has been near zero for a long time. This chart goes back to 2010. During the Trump presidency, the market was doing better, and rates were going higher. We see the big crash during the pandemic. Then inflation happened. Rates have rapidly increased to combat inflation. The Fed Funds rate is currently at 3.08%
Let us also look at the Total Assets held by the Fed. This shows what is called Quantitative Easing. When the pandemic hit, debt markets were struggling to find buyers for company bonds. The Fed bought an enormous amount of these bonds in order to keep the market liquid. The Fed is still holding these assets two years later, and this is one of the big drivers of inflation. Our own central bank is creating inflation by artificially propping up financial markets. As you can see, the Fed is starting to switch from quantitative easing to quantitative tightening as the amount of assets are going down. But we still have a long way to go.
So, there are two things the Fed is doing: Raising rates, and quantitative tightening. Both of these things put downward pressure on financial markets. There is a saying that traders on Wall Street use. They say, “Don’t fight the Fed.” This means that it is not a good idea to bet on the stock market going up, when the Fed is actively doing things that would cause the market to go down.
The combination of increasing rates and quantitative tightening is going to be tough on the economy. A lot of the effects have not yet been fully felt.
Whenever the Fed changes rates, it impacts the rates of all other debt. US Treasuries are largely considered the least risky debt in the world, and so it has the lowest rate which is set by the Fed. All other debt sells at some premium above the US Treasury. For instance, when a large company issues debt, it might trade at a 5% premium over the US Treasury. So, when the US Treasury is at 0%, the company could issue debt at 5%. When the US Treasury is at 3%, the company could issue debt at 8%. Whatever the percentage, the company considers that rate their “Cost of Capital.”
Cost of Capital is a big driver for large companies. Imagine a big company like Amazon. They are starting new projects and business lines all the time. They use their cost of capital to determine which projects to go forward with. If Amazon is being funded with debt, and they have to pay 8% interest, then they know the business has to produce a profit margin higher than 8%, otherwise they are not making any money. When the Fed raises rates, business leaders become less willing to take on speculative projects. They need profitable projects that are sure to make them money, because there is less margin for error. In contrast, when rates are low, business leaders are more willing to try new things, like invest in a crazy crypto startup. When debt is cheaper, it is easier for them to take those risks.
Now we are entering a time when businesses are cutting back. All the speculative investments are going to be wiped out. That is real jobs lost. Amazon is laying off 10,000 workers, Meta 11,000, Twitter, 3,750. Computer World reports that in 2022 tech layoffs affected 182k people. These losses are just happening and you are going to start see markets slow down as unemployed people buy less.
With inflation still high and a long way to go with Quantitative tightening, the economy looks difficult for a long time. What should you do? Be very strategic with your financial decisions and make sure you hit that subscribe button. I release a new video every week to keep you informed about what is going on in the market.
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Neither Zach De Gregorio or Wolves and Finance shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.