Understanding the Federal Reserve and Market Dynamics

Dual mandate

Keep unemployment at ideal rate (5%) and keep inflation in check.

Federal Funds Rate

The short-term interest rate banks charge each other to lend reserves overnight.

Quantitative Easing (QE)

Fed buys long-term securities to lower rates and stimulate the economy.

Quantitative Tightening (QT)

Fed sells or lets bonds mature to remove money from the system.

CPI (Consumer Price Index)

Measures average price changes in a basket of goods and services → tracks headline inflation.

PCE (Personal Consumption Expenditures)

Fed's preferred inflation gauge — more comprehensive, accounts for changing consumer behavior (substitution effect, broader scope).

Option

A type of contract that gives you the right (but not the obligation) to buy or sell something (like a stock) at a certain price before a certain date.

Call option

lets you buy the stock at a set price (called the strike price) before the option expires.

Put option

lets you sell the stock at the strike price before the option expires.

Yield Curve

A graph that plots interest rates (spot rates) of government bonds across different maturities (e.g., 3-month, 2-year, 10-year, 30-year).

Upward-sloping Yield Curve

Long-term > short-term → signals economic growth.

Inverted Yield Curve

When short-term interest rates are higher than long-term rates on government bonds.

Leading indicator of economic downturns

Inverted Yeild curve. Commonly viewed as a leading indicator of economic downturns, historically, recessions often follow an inverted curve within 6-18 months.

Benefited Industries from rising interest rates

Banks and Financials - higher lending margins; Insurance - better returns on reserves; Value sectors like Energy and Industrials.

Harmed Industries from rising interest rates

Real Estate - more expensive borrowing; Utilities - less attractive.

Benefited Industries from lower interest rates

Industries that gain from reduced borrowing costs, including Real Estate, Utilities, Dividend Stocks, and Growth stocks.

Harmed Industries from lower interest rates

Industries that suffer from reduced interest income, including Banks, Financials, and Insurance.

PCE data

Personal Consumption Expenditures data that indicates inflation trends and influences Fed decisions.

Inflation target

The Federal Reserve aims for an inflation rate of 2% before considering rate cuts.

Economic indicators

Factors like inflation, jobs, and current policies that influence the Fed's decisions.

Borrowing conditions

Borrowing is becoming harder with high interest rates, leading to tighter money conditions.

Growth/Tech stocks

Stocks whose future cash flows are discounted more heavily when interest rates rise.

Utilities and Dividend Stocks

Become more appealing in a low bond yield environment.

Banks and Financials harm

Experience shrinking profit margins when interest rates decline.

Insurance industry impact

Faces challenges due to lower yields on investments.

Length of bonds

Refers to the duration until the bond matures, affecting interest rate sensitivity.

Treasury Bills (T-Bills)

Maturity: Less than 1 year (typically 4, 13, 26, or 52 weeks). Issued at a discount and mature at face value (no coupon). Used in short-term rate comparisons, like the 3-month Treasury.

Treasury Notes (T-Notes)

Maturity: 2 to 10 years. Pays a fixed coupon every 6 months. The 10-year Treasury is especially important—it's a benchmark for mortgage rates and investor confidence.

Treasury Bonds (T-Bonds)

Maturity: 20 or 30 years. Fixed coupon payments, semi-annually. More sensitive to interest rate changes due to their long duration.

TIPS (Treasury Inflation-Protected Securities)

Maturity: 5, 10, or 30 years. Principal adjusts with inflation (CPI), and you earn interest on the adjusted principal. Used to hedge inflation risk.

Short-Term Bonds

Mature in 1 year or less. Pros: Very safe, low interest rate risk, good for preserving capital. Cons: Usually lower returns.

Medium-Term Bonds

Mature in 1 to 10 years. Pros: Better yield than short-term, balanced risk and return, still relatively liquid. Cons: More sensitive to interest rate changes, still not as high yield as long-term bonds.

Long-Term Bonds

Mature in 10+ years. Pros: Higher yields, great for long-term income planning. Cons: High interest rate risk, more sensitive to inflation, prices can swing more.

Return on Bonds

Return = Yield (interest + price changes).

Bond Prices and Interest Rates

Bond Prices ↓ when rates ↑.

Investment Grade Bonds

Low risk, liquid, low yield.

High Yield Bonds

Higher risk & return.

Munis

Issued by cities/states, tax-exempt.

Interest Rate Risk

If interest rates go up, the value of your bond goes down. New bonds start paying more interest, so your older, lower-paying bond is less attractive.

Credit Risk (Default Risk)

The company or government that issued the bond might not be able to pay you back.

Liquidity Risk

It might be hard to sell the bond quickly without losing money.

Inflation Risk

If prices (inflation) go up, the money you earn from the bond is worth less.

Interest Rates (Rates)

Help clients manage or bet on changes in interest rates.

Credit

Price and trade debt from companies — both strong (investment grade) and risky (high yield).

Securitized Products

Trade bonds made from bundles of things people owe money on.

Foreign Exchange (FX)

Help clients trade or hedge currency risk.

Emerging Markets (EM)

Help investors get into or out of riskier markets around the world.

Commodities

Help clients hedge or invest in real stuff — energy and materials.

Municipals (Munis)

Help investors earn tax-free income by buying local government debt.

High Yield

Trade debt from companies that need to offer high interest to attract investors.

Floating-Rate Loans

Help clients invest in loans to companies where the rate changes over time.

Broad Markets Fixed Income

Offer clients big-picture fixed income portfolios.

Index

A list or benchmark that tracks how a certain part of the market is doing.

ETF (Exchange-Traded Fund)

A financial product that you can buy and sell on the stock market.

Difference between Index and ETF

An index is just a measurement tool; an ETF is an investment product.