How banks and the Federal reserve / central bank works
On US banks
they pay interest on deposits from customers and either borrow out the money to lenses or purchase short term US treasury . The spread between deposit interest rate paid to customers and US treasury yield/loan interest rate charged to lender is their profit
they charge lenders interest above long term treasury yield rate and finance the loan through either their own deposits or from borrowing
US Banks with deposits above USD122.3million needs to meet minimum reserve requirements of 10% imposed by the Federal reserve as of 2018
Meeting minimum reserve requirements
Borrow from Federal Fund Rate based on central bank interest rates
Used within US economy
rates are higher
hassle free
The federal funds rate is set in U.S. dollars and
charged on overnight loans.
The fed funds rate is the interest rate at which commercial banks in the US lend reserves to one another on an overnight basis
London Interbank Offered Rate (LIBOR) –
Used internationally
Borrow from other banks
rates are lower based on global supply and demand equilibrium
based on USD, EURO, Sterling, Swiss Franc, Yen
Quotations:
overnight, one week, and
one, two, three, six, and 12 months.
Federal reserve debt structure
US treasury bills:
short term maturity at one year or less.
Sold at discount
paid fully at maturity
US treasury notes:
1 year to 9 years maturity
Sold at face value
pays fixed interest rates every six months.
Sold auction style.
US treasury bonds:
10 years to 30 years maturity.
Sold at face value and
pays fixed interest rates every six months .
The original vehicle.
Registered to single owner and cannot be resold.
Federal Interest rate hike
Long term interest rate tend to react faster to hikes then short term interest rates
Long term Federal interest rates are used as benchmarks by banks to determine interest to charge lenders.
To prevent hyper inflation (price stability) after all employable people within the country have been employed into the economy.
Understanding the yield curve
Interest rates are considered the cost of money
The Federal reserve only manipulates the overnight interest rate
Longer term interest rates are determine by demand and supply of money
The Federal reserve increases the overnight interest rate by reducing the supply of money in circulation. This is achieved by supplying more short term securities in the open market, .
The Federal reserve decreases the overnight interest rate by increasing the supply of money in circulation. This is achieved by buying up short term securities in the open market.
Long term interest rates are higher than short term interest rates because long term interest rates require you to endure greater interest-rate uncertainty as well as greater likelihood of government default
