How does the fed add liquidity to the economy?

[RGLD]

There are quite a few complex steps here right? They set a target interest rate by going to the debt market and buying/selling with their printed money until it reaches that point...

How exactly does this help the stock market? Unless they buy stock instead of debt, I don't see how the fed can influence the stock market directly by driving the yield down on 30 year treas bonds. More importantly, how does this make it more liquid? Does the Bond market have some indirectly connection to the stock market?

 

[Same Lazy Element]

There are quite a few complex steps here right? They set a target interest rate by going to the debt market and buying/selling with their printed money until it reaches that point...

Which specific one, them setting the target rate or their QE initiative?

 

[Cuddles]

There are quite a few complex steps here right? They set a target interest rate by going to the debt market and buying/selling with their printed money until it reaches that point...

How exactly does this help the stock market? Unless they buy stock instead of debt, I don't see how the fed can influence the stock market directly by driving the yield down on 30 year treas bonds. More importantly, how does this make it more liquid? Does the Bond market have some indirectly connection to the stock market?

my rube understanding is the lower the IR are set, the more cheap money comps. can borrow. Comps. borrowing cheap money helps their business grow while lowering their cost. Or they can just outright do buybacks and pump it.

 

[toshiaki]

Your thread title asks about liquidity to the economy but your post asks about how it helps the stock market. I think they're two separate issues - that is the fed can improve liquidity directly and indirectly in the economy.

The fed has some direct (they own some special purpose vehicles or you apply to the fed) lending programs for small businesses but I believe they've only made 1 loan or something.

The fed operates indirectly by lowering interest rates which they hope will force banks to make more and cheaper loans. Banks aren't forced to lend money though so they typically choose to only lend to big profitable companies and those that are guaranteed to survive the pandemic and will have an easy time paying back the loans.

Lowering the interest rate increases the value of bonds as the Fed's power over the interest rate affect most people's risk-free rate input in their valuation models. Default rate is also important, as are future expected interest rates (which people suspect J Powell will comment upon on Thursday). Lower cost of borrowing for corporations will allow the companies who need to take on debt but aren't doing well during the pandemic to more easily repay the debt after the pandemic.

As for the link to the stock market, there's no literal link where people can see the Fed's money flowing into the market. People commenting about how money supply/Fed QE etc prop up the market are doing so from a correlation/inductive reasoning perspective. There are anecdotal stories but as far as I know no one has shown the deductive reasoning. But I think the correlations are too strong to ignore.

 

[morganist]

There are quite a few complex steps here right? They set a target interest rate by going to the debt market and buying/selling with their printed money until it reaches that point...

How exactly does this help the stock market? Unless they buy stock instead of debt, I don't see how the fed can influence the stock market directly by driving the yield down on 30 year treas bonds. More importantly, how does this make it more liquid? Does the Bond market have some indirectly connection to the stock market?

You seem to be explaining this whole process from the Open Market Operation aspect of economic control at a central bank, when the central banks buys assets of banks or companies and holds those assets on their balance sheet. The link below should help you to understand it.

https://www.investopedia.com/terms/o/openmarketoperations.asp

There are other ways a central bank can stimulate economic growth, but the method you seem to be leaning to is in the Qualitative Easing direction. I have put a link below to explain Qualitative Easing, which should explain it to you.

https://wiki.mises.org/wiki/Qualitative_easing

 

[RGLD]

Your thread title asks about liquidity to the economy but your post asks about how it helps the stock market. I think they're two separate issues - that is the fed can improve liquidity directly and indirectly in the economy.

The fed has some direct (they own some special purpose vehicles or you apply to the fed) lending programs for small businesses but I believe they've only made 1 loan or something.

The fed operates indirectly by lowering interest rates which they hope will force banks to make more and cheaper loans. Banks aren't forced to lend money though so they typically choose to only lend to big profitable companies and those that are guaranteed to survive the pandemic and will have an easy time paying back the loans.

Lowering the interest rate increases the value of bonds as the Fed's power over the interest rate affect most people's risk-free rate input in their valuation models. Default rate is also important, as are future expected interest rates (which people suspect J Powell will comment upon on Thursday). Lower cost of borrowing for corporations will allow the companies who need to take on debt but aren't doing well during the pandemic to more easily repay the debt after the pandemic.

As for the link to the stock market, there's no literal link where people can see the Fed's money flowing into the market. People commenting about how money supply/Fed QE etc prop up the market are doing so from a correlation/inductive reasoning perspective. There are anecdotal stories but as far as I know no one has shown the deductive reasoning. But I think the correlations are too strong to ignore.

My assumption is when Feds lower interest rates, money has no other place to go, so they're forced into the stock market. This only works if the US stock market is the best, otherwise money will flow to other markets.

 

[2rosy]

maybe it's all inflation adjusted. look at entry level salaries; they've doubled over a short period

 

[RGLD]

maybe it's all inflation adjusted. look at entry level salaries; they've doubled over a short period

You seem to be explaining this whole process from the Open Market Operation aspect of economic control at a central bank, when the central banks buys assets of banks or companies and holds those assets on their balance sheet. The link below should help you to understand it.

https://www.investopedia.com/terms/o/openmarketoperations.asp

There are other ways a central bank can stimulate economic growth, but the method you seem to be leaning to is in the Qualitative Easing direction. I have put a link below to explain Qualitative Easing, which should explain it to you.

https://wiki.mises.org/wiki/Qualitative_easing

This is what I don't get

Open market operations (OMO) refers to when the Federal Reserve purchases and sells primarily U.S. Treasury securities on the open market in order to regulate the supply of money that is on reserve in U.S. banks, and therefore available to loan out to businesses and consumers. It purchases Treasury securities to increase the supply of money and sells them to reduce the supply of money.

If they buy US treasuries, it means they're just lending the government money. How does this add liquidity to the stock market? How does this help corporations make profits? They're just increasing the US debt to a higher percentage owned by the fed. And the government is just going to use them to fund social programs.

 

[tiddlywinks]

If they buy US treasuries, it means they're just lending the government money. How does this add liquidity to the stock market? How does this help corporations make profits? They're just increasing the US debt to a higher percentage owned by the fed. And the government is just going to use them to fund social programs.

1) Buying treasuries on the open market is NOT lending to the government. The open market is NOT new issuance. Since cash is freed up, the money supply increases. To fully grasp the increase, you need to understand the multiplier affect of how banking works... one dollar equals more than one dollar in banking. And not to be forgotten is how money supply affects consumer and commercial credit.

2) The Fed employs MONETARY POLICY. The government employs FISCAL POLICY. They are not the same thing. The houses of government approve issuance of debt, and the Fed carries only out the issuance (and the associated/subsequent monetary policy), not the other way around.

3) Control of the money supply is all about interest rates, which bleeds into foreign exchange rates.

 

[morganist]

This is what I don't get

Open market operations (OMO) refers to when the Federal Reserve purchases and sells primarily U.S. Treasury securities on the open market in order to regulate the supply of money that is on reserve in U.S. banks, and therefore available to loan out to businesses and consumers. It purchases Treasury securities to increase the supply of money and sells them to reduce the supply of money.

If they buy US treasuries, it means they're just lending the government money. How does this add liquidity to the stock market? How does this help corporations make profits? They're just increasing the US debt to a higher percentage owned by the fed. And the government is just going to use them to fund social programs.

Usually Open Market Operations work differently to that. The central bank will usually buy assets banks have and hold them on the central bank's balance sheet. The bank the central bank bought the assets from gets money in exchange for the assets they sold. This gives the banks more liquid cash assets to buy other assets or lend more money out with, increasing the supply of money for stock market investment or borrowing speeding up the rate of transactions within an economy. The central bank expands its asset holdings on its balance sheet but has assets it can sell at a later date, hopefully with a profit. The increase in liquidity is the bank that sold the assets getting liquid cash to invest in the stock market or lend out. The central bank holds the less liquid assets and expands the size and value of its balance sheet or asset portfolio. Got it?