In simple terms, what does the Fed’s interest rate hike mean?

To understand the Fed’s interest rate hikes, you need to first understand the Fed’s basic structure and basic functions.

The Federal Reserve is composed of three parts: the Federal Reserve Board (FRB), the Federal Open Market Committee (FOMC), and 12 regional Federal Reserve Banks located in major cities across the country. These 12 reserve banks have more than 2,000 member banks.

The Federal Reserve Board has 7 executive members, consisting of the chairman, vice chairman and 5 other members. All 7 executive members must be nominated by the president and can take office after being confirmed by Congress. The term of office of the executive members is 14 years, and the term of office of the chairman and vice chairman is 4 years. The Open Market Committee has 12 members, consisting of 5 people selected from the 7 executive members of the Reserve Board and the presidents of the 12 regional Federal Reserve Banks. The president of the New York Federal Reserve has voting rights, and the other 11 will select 4 people to get voting rights in turn. Please refer to the figure below for details:

In terms of responsibilities, the Federal Reserve Board is the authority. The central Federal Reserve Board has the power to approve the appointment of regional Federal Reserve Chairmen and has the dominant power in the monetary policy decision-making and implementation process. It can decide the bank deposit reserve ratio and reserve interest rate, and review the discount rate; the Open Market Committee is the executive body and meets every six weeks, which is what we usually call the Federal Reserve's interest rate meeting. The meeting decides on the market's open operation policy, that is, the direction of monetary policy adjustments, which is usually called the benchmark interest rate. There are three adjustment directions: if the interest rate is raised, the interest rate will be raised; if the interest rate is lowered, the interest rate will be lowered; and the other is to keep the current interest rate unchanged; the 12 local reserve banks, as important participants, participate in the implementation of the Federal Reserve's policies and feedback on economic market conditions.

The Fed members are mainly divided into two factions: doves and hawks. Traditional doves are basically economists from the east and west coasts of the United States, such as those with PhDs from MIT and UC Berkeley. They like to use a lot of academic models and represent the interests of the traditional financial industry. Traditional hawks are basically from the Midwest and southern states of the United States. They represent the interests of the manufacturing, energy, agriculture and other industries in the United States. They advocate market decisions in philosophy, hope for interest rate hikes, dislike quantitative easing, and hate real estate speculation.

The struggle between these two factions will cause the Fed's policies to swing left and right. Before each interest rate meeting, some hawkish or dovish members will make speeches on raising or lowering interest rates, which will affect the market's ups and downs in the short term, but the results of the meeting may be exactly the opposite of what these members said.

Unlike other countries, the Federal Reserve is a private central bank whose main function is to maintain and stimulate U.S. economic growth and ensure U.S. market stability and employment, but it is not actually too concerned about issues such as asset price bubbles and inflation.

By understanding the basic structure and basic functions of the Federal Reserve, we can better understand the path and nature of the Fed's interest rate hikes.

The Fed's interest rate hike essentially increases the lending rate between the Fed and commercial banks, leading to an increase in the cost of borrowing between banks and their peers (the federal funds rate, the benchmark interest rate in the United States), and then raises the lending rate between commercial banks and enterprises and residents. Finally, the interest rate hike affects the investment, consumption and other behaviors of the entire society.

Specifically, all financial institutions in the United States that accept deposits from depositors have a reserve account at the Federal Reserve. The balance of each institution's reserve account cannot be lower than a certain proportion of the short-term deposits it absorbs. This proportion is called the reserve ratio or deposit reserve ratio. Under normal circumstances, banks with insufficient reserves can make up their reserves by taking short-term loans from banks with excess reserves. The interest rate for short-term loans between financial institutions in the market to meet reserve requirements is called the federal funds rate.

The Federal Reserve influences the federal funds rate through open market operations, which refer to the Fed's actions of injecting or withdrawing money into the market by buying and selling bonds. After the Federal Open Market Committee sets the target for the federal funds rate, the Fed changes the amount of money issued in the market through open market operations to achieve the pre-set target interest rate.

The Fed's interest rate hikes and cuts actually reach the target interest rate announced at the interest rate meeting through the above path. In a recession, the Fed supports economic growth by lowering interest rates; conversely, when the economy is overheated or inflation is too high, the Fed will raise interest rates to curb investment and consumption.

It can be said that raising interest rates is a result, and a series of operations are needed to achieve this result. Therefore, after each interest rate meeting of the Federal Reserve, the market will not collapse immediately, and may even rise by inertia until the interest rate target is achieved, and the market will finally fall and collapse. It is like turning off the faucet. The "landlady" first tells the tenant to limit the water supply and turn down the faucet, but she needs to go downstairs and then limit the water by a series of actions such as manually turning the gate. In this process, the water is slowly reduced, giving the tenant a reaction time.

Since the US dollar is the world currency and dominates the global financial monetary system and trade settlement system, this means that the Fed's interest rate hike will not only have an impact on the US economy and other global economies, but will also affect all investment markets including the crypto market.