From zero
05 From zero · Traditional markets · United States

The Fed and interest rates

Interest is the price of time. Understand that sentence and you understand why a meeting of eight people moves the price of everything — and why the market sometimes falls on good news.

Fêr UlianovOpening · 14 s · in Portuguese

The sentence
The Fed held its target range and signalled two cuts this year; stocks fell anyway, because the market had expected three.

Blurred on purpose. The end of it looks like a typo. It isn't.

The idea

Interest is the price of time

A thousand dollars today is worth more than a thousand dollars a year from now. That is not an opinion: with today's you can do something during that year. Interest is exactly what is charged for that difference — rent on money, for the time it spends with somebody else.

Everything else follows. The sum runs both ways: forwards, what your money becomes; backwards, what money arriving far ahead is worth today. It is the backwards direction that moves the stock market, and it is the one almost nobody knows.

Rate per year
$1,000 today becomes, in 10 years
$1,000 ten years from now is worth today
The same rate, read in both directions. Look at the second number: when the rate rises, everything that only arrives in the future shrinks today. Keep that sentence — it is the whole lesson.
Who decides

Eight meetings a year, and an overnight rate

The Fed is the central bank of the United States. Inside it, rates are decided by a committee, the FOMC, which meets eight times a year on dates set far in advance.

And it does not decide the rate on your mortgage. It decides exactly one: the rate banks charge each other to lend money from one night to the next. It is the shortest rate there is — and everything else settles around it.

Notice too that the announcement is not a number but a range. The committee declares an interval it wants the rate to sit within; it is a target, not a decree. That has been the practice since late 2008.

8

Meetings a year

On dates published a year ahead. Outside them, only in an emergency.

overnight

The only maturity it controls

The rate for lending between banks from one day to the next. Nothing else is decided.

2

Obligations, at the same time

Employment at the highest level the economy can sustain, and stable prices. When the two pull in opposite directions, the committee has to choose.

The two obligations are what make the decision hard. High rates hold prices down and hurt employment; low rates do the reverse. There is no number that solves both — there is a choice about which hurts less now.
The price target

“Stable prices” has a number: the Fed aims at 2% inflation a year over the longer run. Not zero, deliberately — zero inflation leaves the economy too close to deflation, which is far harder to fight.

The ladder

How an overnight rate reaches you

The path is always the same, and each step adds a piece. None of them is automatic: they are decisions by different people, which is why the full effect takes months to appear.

  1. The FedAnnounces the range for the overnight rate.
  2. The banksStart funding and lending to each other at a higher price.
  3. CreditCards, mortgages and corporate debt rise with it.
  4. People and firmsPostpone purchases and postpone investment.
  5. PricesWith fewer buyers, inflation eases — and employment suffers.
This is why monetary policy is said to act with a lag. The decision is today's; the effect on the price of bread is many months away.
The trap

The market reacts to what it did not expect

Here is why the sentence at the top is not a mistake. A share's price today already contains what the market thinks is going to happen. If everyone expects three rate cuts and three arrive, nothing happens: it was already in the price.

What moves the price is the difference between what was expected and what came. Two cuts announced when three were expected is a higher rate than forecast — and, by the first chart in this lesson, a higher rate shrinks every future profit today.

That is how half a dozen words in an interview move trillions without any rate having changed. They did not change the rate: they changed the expectation.

The market expected
The committee delivered
Likely reaction of the market

Move both controls. What decides the reaction is not how high either one is, but the distance between them. An illustration of the mechanism: the real market reacts to many things at once.
The proof

Now read the sentence

It's the same one from the top, unblurred. Tap each highlighted part.

The held its and signalled ; stocks , because the market had .
Start here

Five pieces

Each highlighted part hides an idea. Tap one of them.

Five taps and the sentence is done.

You can already answer these

If this landed, the lesson did what it promised

  • Interest is the price of time: money today is worth more than the same money later.
  • A higher rate shrinks the present value of any future profit.
  • The Fed sets a range for an overnight rate; everything else settles around it.
  • The market reacts to the gap between expected and delivered, not to the number itself.

Fêr UlianovClosing · 24 s · in Portuguese

Educational material. No rate level and no official's name appear in this lesson: both change, and the page is meant to last. The figures in the controls illustrate the mechanism — the real market reacts to many things at once. It is not a recommendation to buy or sell.