[eli5] Why is US federal interest rate highly important in the financial world?
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There are only a few currencies that are used a lot in global markets and held widely by most banks. These are the USD, EU, JPY followed by the GBP and RMB.
Banks have to benchmark their costs (interest paid to their depositors) against the interest rates offered by the Central banks of these major currencies. Investors and lenders also benchmark their risk and return against these interest rates. For example: If you could lend someone $100 and get 5% or lend to the US govt for 5%, it is almost certain that the US govt is less risky and would be preferred.
The USD is the major currency for international trade and loans. When the Fed increases their interest rates, it has a very big influence in the cost of borrowing and returns required from investors. This has the effect of “pulling” investment into USD usually strengthening the USD.
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