FOMC Hikes Benchmark Interest Rate, Boosts Economic Projections

by Ike Obudulu Posted on September 26th, 2018

Washington, D. C., USA:  The Federal Open Market Committee, FOMC, raised the target range for the federal funds rate to 2 to 2.25 percent, citing realized and expected labor market conditions and inflation, on Wednesday – a move that was widely expected.

The accompany statement said data received since the Fed’s August meeting indicates the labor market has continued to strengthen and that economic activity has been rising at a strong rate.

The central bank also reiterated that average job gains have been strong in recent months and noted annual inflation remains near 2 percent.

Looking ahead, the Fed said future adjustments to the target range for the federal funds rate will be based on realized and expected economic conditions relative to the central bank’s maximum employment objective and its symmetric 2 percent inflation objective.

“This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments,” the Fed said.

The Fed’s projections for future rate hikes points to one more increase in rates this year and three rate hikes next year.

The outlook for GDP growth in 2018 was upwardly revised to 3.1 percent from 2.8 percent, while the median projection for GDP growth in 2019 inched up to 2.5 percent from 2.4 percent.

“Our view is that the Fed will press ahead with gradual rate hikes for now, but that officials are still underestimating just how quickly the economy is likely to lose momentum next year, as the fiscal boost fades and monetary tightening bites,” said Michael Pearce, Senior U.S. Economist at Capital Economics.

He added, “As economic growth slows below its potential rate around the middle of next year, we expect the Fed to call time on rate hikes and ultimately begin cutting rates by early 2020.”

At 2:30 pm ET, Fed Chairman Jerome Powell is scheduled to hold a press conference to discuss the unanimous decision to raise interest rates and well as the economic outlook.

Market Reaction – Dollar rises, Wall Street rally fizzles, after Fed rate hike

A rally in U.S. equities fizzled out late on Wednesday, while the U.S. dollar rose, after the Federal Reserve raised interest rates, as expected, and flagged the end of its “accommodative” monetary policy.

With steady economic growth and a strong job market, the Fed indicated that it still foresees another rate rise in December, three more next year, and one in 2020.

Though the U.S. dollar was higher, it had briefly stumbled after the Fed decision.

“The strong dollar has been torpedoing everyone’s international investments for the better part of a year or so,” said Jamie Cox, Managing Partner at Harris Financial Group in Richmond, Virginia.

“If the dollar tails off here or just levels off, that is very bullish for emerging markets and other places where that dollar strength has really been a problem.”

The Dow Jones Industrial Average fell 106.93 points, or 0.4 percent, to 26,385.28, the S&P 500 lost 9.59 points, or 0.33 percent, to 2,905.97 and the Nasdaq Composite dropped 17.11 points, or 0.21 percent, to 7,990.37.

The higher greenback also dented the Canadian dollar, which hit its lowest level in more than a week. Concerns that Canada would be left out of a trade deal with its NAFTA counterparts also weighed.

U.S. Treasury yields fell, with the yield curve now at its flattest levels in over a week. Longer-dated yields led the bond market in the wake of Fed Chairman Jerome Powell’s inflation comment.

“His statements on the economy at the press conference was pretty bullish,” said Dec Mullarkey, managing director of investment strategies at Sun Life Investment Management in Wellesley, Massachusetts. “On the inflation front, he saw things as pretty contained.”

Benchmark 10-year notes last rose 14/32 in price to yield 3.0499 percent, from 3.102 percent late on Tuesday.

Earlier in the day, Chinese equity markets had set a positive tone after global index provider MSCI said it could quadruple China’s weighting in global benchmarks. That lent fresh impetus to a market already buoyed by expectations of state stimulus to offset the impact of U.S. tariffs.

Shanghai-listed shares closed almost 1.0 percent higher at eight-week highs and the Hang Seng Index, made up of large Hong Kong companies, rose 1.15 percent.

The pan-European FTSEurofirst 300 index rose 0.27 percent and MSCI’s gauge of stocks across the globe shed 0.15 percent.

The dollar index rose 0.15 percent, with the euro down 0.25 percent to $1.1741. The Japanese yen strengthened 0.25 percent versus the greenback at 112.74 per dollar.

Oil prices eased off four-year highs above $82 hit on Tuesday but were still set for a fifth consecutive monthly quarter of gains, driven by a looming drop in Iranian exports in the last quarter of the year when global demand heats up.

U.S. crude fell 0.43 percent to $71.97 per barrel and Brent was last at $81.10, down 0.2 percent on the day.

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.

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