Washington, D. C., USA: The Federal Open Market Committee, FOMC, raised the benchmark interest rate by 25 basis points to a new corridor of 1.75%-2% at the end of it’s two-day policy meeting on Wednesday. The Fed signaled two more rate hikes likely this year, four in 2019.
The increase, which is in line with economist’s expectations marks the seventh time since the financial crisis, that the Federal Reserve has raised the benchmark interest rate.
The move reflects the economy’s resilience, the job market’s strength and inflation that is finally nearing the Fed’s target level.
The action means consumers and businesses will face higher loan rates over time.
However, with rates markets pricing in a 100% probability of a hike, forward guidance – the path for hikes in the remainder of 2018 – will be the pivotal aspect of today’s rate decision.
Markets focus shifts to press conference with Fed chair Jerome Powell which follows at 2:30 p.m. ET. for the Fed’s updated economic projections which include the “dot plot,” a table that shows future interest rate expectations from Fed officials. In March, the dot plot showed that Fed officials were roughly split on whether two or three additional rate hikes in 2018 would be warranted.
Market pricing suggests traders are split on whether the Fed will raise rates three or four times this year. The hawks expect the dots will show a four-hike baseline for 2018, up from three at the March meeting.
Since the Fed raised interest at its March meeting, the unemployment rate has dropped a further 0.3% to a 48-year low of 3.755% while the economy has added 537,000 jobs over that period.
The biggest source of volatility for the US Dollar will come from the updated Summary of Economic projections. With the unemployment rate below 4% and headline US inflation at its highest rate in more than six years, there is a legitimate case to be made by Fed officials that the odds of two more rate hikes this year is more than a coin flip – and at 51% implied probability, odds for four cumulative hikes this year is basically a coin flip.
To this end, an upgraded Summary of Economic Projections coupled with a tone tilted more hawkish today by Fed Chair Jerome Powell should prove supportive for the US Dollar.
Here is the full FOMC statement:
Federal Reserve issues FOMC statement
“Information received since the Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Job gains have been strong, on average, in recent months, and the unemployment rate has declined. Recent data suggest that growth of household spending has picked up, while business fixed investment has continued to grow strongly. On a 12-month basis, both overall inflation and inflation for items other than food and energy have moved close to 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its 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.
Voting for the FOMC monetary policy action were Jerome H. Powell, Chairman; William C. Dudley, Vice Chairman; Thomas I. Barkin; Raphael W. Bostic; Lael Brainard; Loretta J. Mester; Randal K. Quarles; and John C. Williams.”
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.