Washingoton, DC, USA: The Federal Reserve voted to keep interest rates unchanged following today’s conclusion of the Federal Open Market Committee (FOMC) two-day meeting. The tally to keep rates unchanged which was unanimous was widely expected. The consensus view is that borrowing costs will go up by March when the FOMC meets again.
As to the Fed’s rationale for holding the line here, the bank said that while it expects inflationary pressures to heat up as the year moves along, there was not yet a major move higher by prices. Heretofore, the Fed had been indicating that it expected inflation to hold below the bank’s 2% objective. Now, it sees that level being reached in the current 12 months.
The projected rise in overall inflation this year–and we did see some wage pressures emerge in 2017–could cause the Fed to raise rates as many as four times this year, with an uptick in December providing that fourth increase. As to the reaction to the Fed’s statement, the Dow Jones Industrial Average, up by 150 points before the 2:00 statement, pulled back some after the issuance.
All in all, we do not see this meeting as a game changer, but do look for the central bank, soon to be under new stewardship, to take a somewhat more aggressive, or hawkish, monetary stance going forward. How hawkish the Fed becomes, and we are not looking for a see change here, could determine just how strong the stock market remains going forward.
The Federal Open Market Committee meeting
The Federal Reserve Act of 1913 charged the Federal Reserve with setting monetary policy to influence the availability and cost of money and credit.
The Federal Open Market Committee (FOMC) meeting is a regular session held by the members of the Federal Open Market Committee, a branch of the Federal Reserve that decides on the monetary policy of the United States.
During these meetings, the FOMC reviews economic and financial conditions and determines the federal funds target rate
A decline in the target rate could stimulate economic growth; however, too much economic activity can cause inflation pressures to build. A rise in the rate limits economic growth and helps control inflation pressures; however, too great an increase can stall economic growth. The FOMC seeks a target rate that will achieve the maximum rate of economic growth.
A change in the federal funds rate can affect other short-term interest rates, longer-term interest rates, foreign exchange rates, stock prices, bond prices, the amount of money and credit in the economy, employment and the prices of goods and services.
So traders and investors around the world usually attempt to predict where monetary policy is headed next in each Fed meeting, and adjust their strategies and portfolios accordingly.
The Federal Funds Target Interest Rate
The federal funds rate is the interest rate that banks charge each other for overnight loans, meaning that it effectively acts as the base interest rate for the US economy. Changes to the federal funds rate will impact short and long-term interest rates, forex rates, and eventually economic factors like unemployment or inflation. This, in turn, will play out across the global economy.
While it doesn’t have a direct say over the rates charged by banks to lend money to each other, the FOMC can indirectly change the fed funds rate using three policy tools that affect money supply. These are open market operations, the discount rate, and reserve requirements.
Open market operations are the buying and selling of government bonds on the open market.
When the FOMC wants to decrease monetary supply it will sell bonds, taking money out of the economy and in turn raising interest rates. When it wants to increase money supply, it will buy bonds, injecting money into the economy and lowering rates.
As well as borrowing this money from each other at the federal funds rate, banks can borrow money directly from the Federal Reserve itself.
The interest rate a bank will have to pay to borrow from the Fed is called the discount rate. A lower discount rate will encourage a lower federal funds rate, and vice versa.
Reserve requirements are the percentage of a bank’s deposits from customers that it has to hold in order to cover withdrawals.
If reserve requirements are raised, then banks can loan less money and will ask for higher interest rates. If they are lowered, then the opposite happens.
Quantitative easing (QE) is an extra measure that the Fed can apply in times of severe financial situation. It is usually only used once the above policy tools have been exhausted.
In function, QE looks fairly similar to open market operations. The FOMC buys securities on the open market, injecting money directly into the system.