The Federal Reserve Act of 1913, modified by the banking acts of 1933 and 1935, created the Federal Reserve System, the central bank of the United States. The responsibilities of the Fed, as it is commonly known, falls into four categories. The Fed supervises and regulates the banks to ensure the safety and financial soundness of the country's banking system. It maintains the stability of the financial system and contains any systematic risk that may arise in the financial markets. It provides financial services to the US government, financial institutions, foreign official institutions and the public, including playing a major role in the foreign exchange markets. The Fed also conducts the nation's monetary policy by effecting the money and credit conditions in the economy.
BASIC TECHNIQUES
The Next Discount Rate Change
by Steven M. Morris
Here's a review of the changes in the discount rate, and the implications for investors.
That last responsibility is implemented in numerous ways. One way is to regulate the growth of the economy by adjusting the discount rate, which is the rate the Fed charges on its short-term loans to banks and other depository institutions in its role as lender of last resort. Increases in the discount rate can lead to a restrictive credit situation in the economy, and slow economic growth. On the other hand, lowering the discount rate will increase the available supply of credit and generally aid the growth rate of the economy.
Analysts use changes in the Federal Reserve discount rate as a major indicator for the direction of the stock market. In general, cuts in the discount rate bode well for the market, but rate hikes do not. Fed watchers must try to anticipate the monetary policy that the Federal Reserve Board sets in order to position their portfolios properly. Can we use previous discount rate changes to give us some insight into the direction of future changes?
DISCOUNT RATE HIKES
Figure 1 shows the number of discount rate hikes and cuts since 1934, categorized by time since the previous change. The raw data on Fed discount rates used was obtained from the Federal Reserve Bank of St. Louis Fred database. Significantly, the majority of discount rate changes occur within 90 days of a previous change. Of the 113 changes observed since 1934, more than half -- 59, to be precise -- occurred within this time frame. But with the exception of the 90- to 180-day period, there appears to be no statistically significant difference between the number of interest rate hikes and interest rate cuts during any of these periods.
Excerpted from an article originally published in the October 1998 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 1998, Technical Analysis, Inc.
