The Federal Reserve's fame comes from its high profile position as the manager of monetary policy. The Federal Open Market Committee (FOMC), composed of the seven governors and five district bank presidents, meets eight times a year to set the agenda for monetary policy based on economic (and inflation) conditions. The president of the New York Federal Reserve is a permanent voting member of the FOMC, but the remaining 11 district bank presidents alternate their terms as voting members.

When the economy is booming, it is the Fed's role to dampen activity by tightening credit conditions or raising interest rates in order to preclude the onset of inflationary pressures. When the economy is sagging (with no inflation), it is partly the Fed's job to give it a booster shot by easing credit conditions and reducing interest rates.

In recent decades, most heads of the Fed left notable legacies and had major impact on the economy and financial markets.  Paul Volcker, appointed by President Jimmy Carter, stunned financial markets in late 1979 by declaring his intentions to target monetary aggregates (M1, M2, and M3 at the time) in order to eradicate the high inflation of the period. Volcker vacillated back and forth between targeting monetary aggregates and the federal funds rate. He dramatically altered the course of inflationary expectations in the 1980s. He also set the stage for his successor.

Alan Greenspan surpassed Volcker in celebrity in the late 1990s, but followed a similar path of inflation reduction. Greenspan's background as an economic consultant and forecaster meant that the Fed would monitor conditions somewhat differently from the Volcker era. Moreover, the age of information technology ensured that ever more individuals, not just market professionals, would become enamored with the Fed watching process. A new era of Fed watching was born –one in which monitoring economic indicators would surely give analysts a leg-up on the competition. Fed watchers had existed before, but they were conditioned to monitor arcane details.   The Greenspan era ended on January 31, 2006 after roughly 18 years.

President George W. Bush appointed a well-respected monetary economist to fill the position of chairman: Ben Bernanke. Until 2002, the bulk of Dr. Bernanke's career was in academia. However, he served as a Federal Reserve governor for three years and as Chairman of the President's Council of Economic Advisors for a short period as well.

Chairman Bernanke continued the tradition of closely monitoring economic indicators and economic conditions around the globe.   His term as chairman ended January 31, 2014 but not before engaging the Fed in creative monetary policies.  In response to the recession beginning at the end of 2007 and subsequent financial crisis, the Fed cut the fed funds target rate to essentially zero, established numerous emergency lending facilities to prop up financial institutions, began several rounds of quantitative easing, and established two additional policy tools—interest paid on excess reserves and also reverse repos.  A key accomplishment of Bernanke was to increase transparency in monetary policy, including more frequent Fed forecasts, establishing an inflation goal, increased guidance in FOMC statements, and holding chairman press conferences after the releases of Fed forecasts.

President Barack Obama appointed Janet Yellen to take office as Fed chair on February 1, 2014.  She previously served as president of the Federal Reserve Bank of San Francisco and as vice chair of the Federal Reserve Board of Governors.  Her immediate task was to oversee the taper of quantitative easing set in place prior to her becoming chair.  That is to be followed eventually by normalization of monetary policy, including a return a neutral fed funds target rate and an unwinding of the Fed’s balance sheet.

Deciphering Fed policy and Fedspeak is time consuming but necessary to understand the impact on financial markets. 

Interest rate policy affects economic growth and inflation.  And changes in the Fed’s balance sheet affect interest rates. So how could investors not care about the Federal Reserve? Bond investors and equity investors prefer a low interest rate environment. In contrast, the foreign exchange value of the dollar benefits from a high interest rate environment (as long as it is not accompanied by inflation.)