Impact of Federal Reserve Monetary Policy on Financial Markets

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1 Effects of the Federal Reserve’s Monetary Policy on the Financial Institutions and Markets Student’s Name Institutional Affiliation Course Instructor Date

2 Federal Reserve Monitoring and Influence on Employment and Inflation The Federal Reserve influences the United States’ economy. Over the years, the central bank’s objectives have undergone several transformations to maximize sustainable employment and promote price stability. The U.S. market is unique and integral in shaping the approach taken by financial institutions to remain profitable. The Federal Reserve stands out as the most powerful financial institution in the U.S. Some of its responsibilities revolve around regulating financial markets, defining and setting interest rates, and managing the money supply. Also, the central bank assumes the responsibility of the final lender option when the country faces an economic crisis, as witnessed during the COVID-19 pandemic and the 2008 - 2009 financial meltdown. Different financial institutions have responded differently to mitigation and regulatory measures placed by the Federal Reserve. Banks such as JP Morgan Chase have stood the test of time in adjusting and responding to monetary policies set by the central bank. The Federal Reserve monitors unemployment by keeping track of key labor market indicators, such as nonfarm payroll employment, labor force participation trends, and the unemployment rate. That way, it is well-positioned to analyze the state of the U.S. job market. Of all the indicators under its jurisdiction, the unemployment rate remains the most significant because it gives an insight into the unemployed labor force seeking employment. Brown (2019), highlights that there has been a steady decline in unemployment rates during periods of economic expansion. Such trends are attributed to the fact that businesses are facing huge market demands which must be matched. The Federal Reserve Policy relies on monetary policy decisions to influence employment. The Reserve is strategic by capitalizing on the federal funds rate to create such an influence (Davis et al., 2017). The federal funds rate is the interest rate at which credit unions and banks

3 lend to the Reserve; hence, any changes directly influence consumers' and businesses' borrowing and spending patterns. It is important to note that the Federal Reserve has been at the forefront of implementing visionary monetary policies to spur economic growth and reduce unemployment. The Federal Reserve strategically makes borrowing cheaper by lowering the federal funds rate. With lower interest rates, businesses get the urge to expand operations through investments which ultimately leads to the onboarding of more workers. Also, Saadaoui & Mokdadi (2022) allude to the notion that such moves encourage consumers' borrowing to be channeled to purchases such as automobiles and homes, boosting spending and economic growth. The expansion policy played an integral role in mitigating the unemployment rate during the 2008 – 2009 financial crisis (Brown, 2019). For instance, the Fed ensured that the unemployment curve was on a decline by its decision to reduce the federal funds rate significantly. Price stability remains one of the key objectives of the Federal Reserve. The Fed is responsible for monitoring a series of inflation matrices such as the Personal Consumption Expenditures (PCE) and the Consumer Price Index (CPI) to inform its assessment of the price level of goods and services in the U.S. market. CPI and PCE indices are integral in helping Fed track inflation deviations from its predetermined target range (Nguyen, 2023). Another notable development is that the Fed's monetary policy directly influences inflation with the federal funds rate in play. The Federal Reserve may implement expansionary monetary policies to counter deflation to stimulate the economy (Nguyen, 2023). A lower federal funds rate encourages spending and investment, directly proportional to the demand for goods and services. With that in place, the Fed can push inflation toward its target. It is important to note that during the 2008 – 2009 financial crisis, the Feds lifted inflation by injecting liquidity and lowering interest rates.

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4 The Federal Reserve may implement a contractionary monetary policy due to an increase in inflationary pressures. An increase in federal funds rate increases borrowing costs, contributing to reduced business and customer spending. Reduced spending suppresses demand which in turn controls inflationary pressures. Traditional and Nontraditional Monetary Policy Tools Traditional Monetary Policy Tools Open Market Operations Open market operations are integral in controlling the financial system's liquidity and short-term interest rates. The Federal Reserve is directly involved in buying and selling the country's treasury securities in the market. For instance, the Reserve buys securities from the county's top institutions before channeling money directly into the financial system, which raises reserves. As a result, the federal funds rate is stabilized, leading to affordable borrowing. The Federal Reserve’s action to sell securities lowers the money supply leading to an increase in funds rate. The net effect of such a move is a solid monetary policy that benefits all industry players. Discount Rate The Fed can influence the cost at which banks can borrow regardless of the economic conditions. Banks can obtain more reserves from the central Bank with a lower discount rate. The net effect of increased borrowing is a rise in liquidity, spurring economic activities. On the other hand, an increase in the discount rate translates to episodes of expensive borrowing. Reserve Requirements The Federal Reserve can directly impact interest rates and money supply since it controls financial institutions and their lending rates. A decrease in reserve requirements translates to a

5 corresponding increase in the money that financial institutions can lend. On the other hand, an increase in reserve requirements lowers the capacity to lend, leading to stringent monetary conditions. Nontraditional Monetary Policy Tools Quantitative Easing (QE) The Federal Reserve introduced QE to counter the 2008 financial crisis. The process entails buying securities from the market. Examples of securities in consideration are mortgage- backed and treasury bonds. Implementing a QE aims to increase the money supply through reduced long-term interest rates. The net result of having a QE in place is to encourage spending and investment through sustainable borrowing. Forward Guidance The Federal Reserve relies on a communication tool, forward guidance, to control market expectations. Over the years, the Federal Reserve has communicated its intentions on crucial decisions such as adjustment rates. Therefore, forward guidance is an important communication tool and an asset to the Federal Reserve in its quest to make its intentions clear to all market stakeholders. Pros and Cons of the Federal Reserve’s Implementation Decisions are guided by sustainable employment and price stability. On the other hand, prevailing economic conditions directly impact the choice of policy tools. Expansionary Monetary Policy The three main pros of the expansionary monetary policy are increased economic activity, support to asset prices, and reduced unemployment. An expansionary policy can reduce interest rates by facilitating a conducive environment for borrowing and spending. That way,

6 there is a higher chance of mitigating the effects of depression and recession, boosting the state of the economy. Secondly, an expansionary policy raises real estate and stocks, directly impacting consumer confidence and wealth, leading to a stable economy. Finally, businesses can reduce unemployment by increasing their borrowing and spending patterns leading to improved consumer confidence and market conditions. On the other hand, the cons are the risk of inflation and asset bubbles. As much as expansionary policy is keen on boosting economic activity, it can cause increased inflationary pressures to the extent of reducing consumer confidence and purchasing power. Contractionary Monetary Policy The pros of contractionary monetary policy are rebuilding policy space, mitigating asset bubbles, and controlling inflation. The Federal Reserve can regulate rates by restoring the existing policy space. Also, the policy can prevent the formation of asset bubbles eliminating financial imbalances. Finally, it controls inflation by increasing interest rates, reducing spending and borrowing. On the other hand, its cons are the increasing risk of market volatility and slower economic growth. Implementing a contractionary policy contributes to market uncertainty causing an increase in investor behavior and asset price. Also, stringent measures in monetary policy contribute to reduced investment, spending, and borrowing, slowing down job creation and economic growth. JP Morgan Chase Financial Situation in the Last Five Years The past five years have seen JP Morgan Chase maintain a dynamic financial performance that has positioned it as a leading financial institution in the U.S. One notable development is that shifts and challenges in the investment banking sector have characterized the

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7 company's financial situation. The recent deal-making slowdown has slowed down the Bank's investment banking revenue. According to the Bank's chief operating officer, Daniel Pinto, the Bank may witness a 45% to 50% decline in its third-quarter banking revenue compared to 2022. Also, the Bank registered $3.3 billion in investment banking revenue in 2020 for stock issuance and IPOs. On the other hand, the company has witnessed a huge hurdle in the current market. For instance, its capital markets activity is at an all-time low, with declining mergers and slowed IPOs. This turn of events presents a sharp contrast to the once vibrant conditions. On the other hand, JP Morgan Chase remains on course in its quest to amend its cost structure to align with opportunities in the global investment banking environment. Pinto highlights that the financial institution has been contemplating the possibility of reduced employee bonuses and job cuts to streamline the Bank with current market trends. In all these, JP Morgan has received a boost over the last year from trading. For instance, the Bank expects a 5 percent increase in revenue compared to the previous year due to solid activities around fixed income. Response to Changes in the Federal Reserve's Monetary Policy As a leading financial institution, JP Morgan Chase has embraced an adaptable and responsive approach to Federal Reserve's monetary policy changes. The Bank alludes to the Reserve's policy decisions and constantly aligns its vision to mitigate risks while capitalizing on available opportunities. Under the leadership of its CEO, Jamie Dimon, JP Morgan Chase has responded strategically to changes in the Federal Reserve’s monetary policy on matters related to interest rates and inflation. Dimon pinpoints that the financial institution doesn’t have the urge to rush to celebrate against inflation (Nguyen, 2023) . Such a move indicates its awareness of potential challenges that may emerge from price increases. The fact that Dimon suggests that

8 there is the possibility of the Federal Reserve increasing interest rates above 5% if inflation doesn't fall is a hint of the Bank's readiness to handle any possible scenarios that may arise (Nguyen, 2023) . Also, the Bank acknowledges that further rate hikes are unavoidable, with a constant inflation rate of between 3.5% and 4%. This acknowledgment implies the Bank's commitment to adapt to the rapidly evolving economic environment. Effect of Federal Reserve’s monetary policy The Federal Reserve's monetary policy directly influences JP Morgan Chase's adaptation to the financial market. It is important to note that the Bank has a deeper connection to the global financial system, contributing to its sensitivity to changes in credit conditions, interest rates, and other economic changes. One of the main impacts of the Reserve's monetary policy on the financial institution is the deviations in interest rates. For instance, any adjustments made by the Federal Reserve influence the Bank's interest rates. As a result, the Bank's lending costs and borrowing are directly affected, leading to unpredictability in profits and net interest margin (NIM). The Federal Reserve controls the financial environment by implementing an expansionary policy leading to a decline in the Bank's borrowing costs and interest expenses. The net effect is that the Bank gets an opportunity to dispense cheaper credit to business entities and consumers, increasing interest income. The period of contractionary policy in 2009 had the Federal Reserve increase interest rates to regulate the economy (Son, 2022). However, such a move impacts financial institutions by increasing borrowing costs and lowering interest margins. JP Morgan Chase is not an exemption since higher interest rates directly affect borrowing patterns from businesses and consumers during and after the covid-19 pandemic. Another important development is that the expansionary policy translates to the Bank's increase in loan

9 litigation. Son (2022) subscribes to the notion that financial institutions are pushed to encourage borrowing due to lower interest rates imposed by the expansionary policy. Also, the Bank's revenue can be directly impacted by witnessing slower loan growth. Son (2022) subscribes to the notion that the Federal Reserve's actions regarding monetary policy can be strategically observed, not financial entity gets cushioned from its short and long-term impact. Federal Reserve’s Monetary Policy Direction The choice of direction depends on a combination of factors such as employment and inflation. Notably, the U.S. economy is gradually recovering from the impact of COVID-19, leading to adoption of a flexible monetary policy to support economic recovery. The Federal Reserve may be forced to adopt asset purchase programs if the economy remains steady on its path to recovery. Therefore, the Federal Reserve may allude toward a contractionary policy that is less accommodative. Impact on JP Morgan Chase and Financial Markets The Bank may be forced to increase its borrowing costs due to rising interest rates altering its net interest margin. In addition, there is the possibility of a decline in the demand for leans with a special focus on housing, an interest-sensitive sector. According to Brown (2019) , unprecedented changes in the Federal Reserve's policy directly affect trading volumes and asset valuations. The net effect is that financial giants such as JP Morgan Chase may witness declined investment portfolio performance and trading revenues. Response to Federal Reserve's Monetary Change JP Morgan Chase may regularly update its customers with new insights on finance management in an ever-changing business environment for the current and next financial years. Another response is to constantly review risk management strategies in anticipation of making

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10 crucial adjustments to maintain asset quality amidst economic uncertainties. According to Brown (2019) , JP Morgan Chase has the prowess to make necessary adjustments to manage risk, as witnessed during the COVID-19 pandemic. Finally, it may need to reassess its strategies for increasing interest rates on investment decisions and lending activities.

11 References Brown, M. (2019). Federal Reserve Monetary Policy when reserves pay interest. A Century of Federal Reserve Monetary Policy , 151–174. https://doi.org/10.1142/9789811201783_0015 Davis, S., & Zlate, A. (2017). Monetary policy divergence, net capital flows, and exchange rates: Accounting for endogenous policy responses. Federal Reserve Bank of Dallas, Globalization and Monetary Policy Institute Working Papers , 2017 (328). https://doi.org/10.24149/gwp328 Hugh, Son., (2022). No end in sight for wall street deals slump as JPMorgan says advisory revenue plunges 50% . CNBC. https://www.cnbc.com/2022/09/13/wall-street-slump-leads- to-50percent-plunge-in-jpmorgan-advisory-revenue.html Nguyen, L. (2023). Exclusive: JPMorgan CEO says too early to declare victory against inflation . Reuters. https://www.reuters.com/business/jpmorgan-ceo-says-economy-doing-okay-cites- potential-storm-clouds-2023-02-08/ Saadaoui, Z., & Mokdadi, S. (2022). Bank capital buffers and optimal diversification strategies during and after the Great Financial Crisis. SSRN Electronic Journal . https://doi.org/10.2139/ssrn.4183930

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