FOMC Holds Interest Rates, No Longer Expects Rate Hikes This Year

by Ike Obudulu Last updated on May 1st, 2019,

Washington: In a widely anticipated move, the Federal Reserve announced its decision Wednesday to leave interest rates unchanged following a two-day monetary policy meeting.

The Fed decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent in support of its mandate of fostering maximum employment and price stability.

The central bank’s forward projections also indicated interest rates are likely to remain unchanged for the remainder of the year.

The forecast for interest rates to be unchanged at the end of the current year compares to the December projections indicating two rate hikes.

The downward revision to the rate projections comes as the Fed noted data received since its January meeting points to a slowdown in economic growth from the solid rate seen in the fourth quarter of 2018.

“Recent indicators point to slower growth of household spending and business fixed investment in the first quarter,” the Fed said.

The Fed also noted overall inflation has declined due to lower energy prices but said inflation for items other than food and energy remains near 2 percent.

Looking ahead, the central bank downwardly revised its forecasts for overall consumer price inflation, although core inflation is expected to remain at 2 percent over the next three years.

The Fed reiterated that it will be patient as it determines future adjustments to interest rates to support a sustained economic expansion, strong labor market conditions, and inflation near 2 percent.

Meanwhile, the Fed also confirmed that it intends to conclude the gradual reduction of its balance sheet by the end of September.

The Fed noted it plans to slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions from the current level of $30 billion to $15 billion beginning in May 2019.

The central bank also said its intends to continue to allow its holdings of agency debt and agency mortgage-backed securities to decline, consistent with the aim of holding primarily Treasury securities in the longer run.

Market Reaction

The Dow Jones Industrial Average and S&P 500 closed lower on Wednesday after the Federal Reserve’s latest monetary-policy announcement dragged Treasury yields lower, pushing bank shares down.

Goldman Sachs led the 30-stock Dow to ended the day down 141.71 points at 25,745.67. The S&P 500 closed 0.3 percent lower at 2,824.23. The Nasdaq Composite eked out a gain, closing 0.1 percent higher at 7,728.97.

The Fed brought down its 2019 rate-hike forecast to no increases down from two hikes. The central bank also indicated it intends to end the reduction of its massive $4.2 trillion balance sheet by September. However, the Fed also trimmed its economic growth forecast for 2019.

Stocks initially rallied off their lows of the day on the announcement as traders cheered a more accommodative policy stance from the Fed, which is typically supportive of equity prices.

“Expectations were to remove one dot from the dot plot and to have some description of when the balance sheet run-off would conclude,” said Art Hogan, chief market strategist at National Securities. “This actually exceeds expectations.”

However, the Fed’s announcement also dragged down yields, which in turn knocked bank stocks lower. The benchmark 10-year rate falling to its lowest level in a year to trade at 2.532 percent. The 2-year yield also dropped to 2.4 percent.

Bank stocks fell broadly along with rates. The SPDR S&P Bank ETF (KBE) dropped 3.2 percent. Goldman Sachs declined 3.4 percent while Bank of America, Morgan Stanley, J.P. Morgan Chase and Citigroup all fell at least 2 percent.

“The market might be pricing in more than a cut through next year,” said Mike Collins, senior portfolio manager at PGIM Fixed Income. “It feels like their done.”

However, “it’s really a tricky spot. If things slow too much and the Fed starts cutting, that’s actually not a great environment for equities or corporate earnings or credit risk,” Collins said. “It can become a self-fulfilling prophecy, for sure.”

Equities were also under pressure after President Donald Trump said U.S. tariffs on Chinese goods could stay on for a long period of time.

“We’re not talking about removing [tariffs], we’re talking about leaving them for a substantial period of time because we have to make sure that if we do the deal with China that China lives by the deal,” Trump told reporters. His comments confused some traders, however, as Trump also said a deal is “coming along nicely.”

His comments come a day after reports some U.S. officials are worried China could walk back on some concessions. However, U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin both plan to travel to Beijing next week for another round of negotiations with Chinese Vice Premier Liu He. These reports buffeted stocks on Tuesday.

China and the U.S. have been working on a deal for weeks and investors have priced in one being done. Concerns over global growth also weighed on stocks prior to the Fed’s announcement.

FedEx shares fell more than 3 percent after CFO Alan Graf warned in the company’s quarterly report that “slowing international macroeconomic conditions and weaker global trade growth trends continue, as seen in the year-over-year decline in our FedEx Express international revenue.”

That warning was followed by UBS CEO Sergio Ermotti saying this is one of the worst first-quarter environments ever as investment banking revenue falls about a third from the year-earlier period. Meanwhile, German auto maker BMW said its earnings could fall significantly in 2019 and added it will cut $13.6 billion in costs.

“We’re not out of the woods by any means,” said Christian Fromhertz, CEO of The Tribeca Trade Group. “These are things that continue to be bumps in the road with the equity market.”

“The Fed needs to stay dovish and you need a trade deal to eventually get done. You’re seeing that through FedEx and BMW.”

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.

Leave a Reply