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Economic 101 question regarding Fed interest rate
Posted on 6/5/15 at 12:47 pm
Posted on 6/5/15 at 12:47 pm
It's actually a two parter:
1) I understand the Fed interest rate is currently at 0% but will likely raise that rate sometime this year or in 2016. The interest on these Fed loans generate money, I assume. When that interest rate goes up, where does the money raised go? Or maybe a better way to ask it would be: does the Fed offering 0% interest loans reduce money to the Treasury?
2) I see that every time good news occurs- a drop in unemployment, a rise in durable goods or other positive signs of economic growth- the markets react negatively (sometimes violently so), as they feel that means the Fed will raise interest rates sooner rather than later. why can't the market just price this in like they do for earnings reports? It's going to happen.
1) I understand the Fed interest rate is currently at 0% but will likely raise that rate sometime this year or in 2016. The interest on these Fed loans generate money, I assume. When that interest rate goes up, where does the money raised go? Or maybe a better way to ask it would be: does the Fed offering 0% interest loans reduce money to the Treasury?
2) I see that every time good news occurs- a drop in unemployment, a rise in durable goods or other positive signs of economic growth- the markets react negatively (sometimes violently so), as they feel that means the Fed will raise interest rates sooner rather than later. why can't the market just price this in like they do for earnings reports? It's going to happen.
This post was edited on 6/5/15 at 12:57 pm
1
Posted on 6/5/15 at 1:51 pm to ClientNumber9
The funds generated are returned to the treasury and used to fund the government/pay down debt.
This is kind of a counterintuitive thing, but the fed actually makes more money in falling interest rate environments because their bonds are appreciating.
The reason that they can't fully price it in is because of the whipsaw effect that rising interest rates, even slightly, will drastically effect the market. It is partially priced in, but think of it this way: if there is a 50/50 shot of something happening, you won't have to adjust your price before hand, but you will have to adjust it a lot after hand. If you are 90% positive something will happen and it happens, the effect of the news will be small. If it doesn't happen, the adjustment will be very large. Same thing applies to severity.
This is kind of a counterintuitive thing, but the fed actually makes more money in falling interest rate environments because their bonds are appreciating.
The reason that they can't fully price it in is because of the whipsaw effect that rising interest rates, even slightly, will drastically effect the market. It is partially priced in, but think of it this way: if there is a 50/50 shot of something happening, you won't have to adjust your price before hand, but you will have to adjust it a lot after hand. If you are 90% positive something will happen and it happens, the effect of the news will be small. If it doesn't happen, the adjustment will be very large. Same thing applies to severity.
Posted on 6/5/15 at 2:06 pm to TheHiddenFlask
quote:While true, it's still strange that a probable .25% increase appears to scare investors as much as it does. It's not like we're suddenly going to get a 2% rate.
The reason that they can't fully price it in is because of the whipsaw effect that rising interest rates, even slightly, will drastically effect the market. It is partially priced in, but think of it this way: if there is a 50/50 shot of something happening, you won't have to adjust your price before hand, but you will have to adjust it a lot after hand. If you are 90% positive something will happen and it happens, the effect of the news will be small. If it doesn't happen, the adjustment will be very large. Same thing applies to severity.
Posted on 6/5/15 at 2:58 pm to jturn17
Going to .25% will cause the market to react significantly, because of the pricing in o expected future raises.
Right now hedge funds would have to have balls of steel to go toe to toe with the fed on interest rates. Once the first crack shows, there will be a feeding frenzy of bond selling and shorting.
Right now hedge funds would have to have balls of steel to go toe to toe with the fed on interest rates. Once the first crack shows, there will be a feeding frenzy of bond selling and shorting.
Posted on 6/5/15 at 3:09 pm to jturn17
quote:
While true, it's still strange that a probable .25% increase appears to scare investors as much as it does. It's not like we're suddenly going to get a 2% rate.
It's not the amount, it's the trend.
Posted on 6/5/15 at 3:12 pm to LSUFanHouston
Right. It's a "not what I said, but what I knew you would assume it meant" scenario.
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