Washington, D. C., USA: The Federal Reserve said it will be “patient” on any future interest-rate moves and signaled flexibility on the path for reducing its balance sheet, in a substantial pivot away from its bias just last month toward higher borrowing costs.
The Federal Open Market Committee “will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support” a strong labor market and inflation near 2 percent,” the central bank said in a statement Wednesday following a two-day meeting in Washington.
In a separate special statement on Wednesday, the Fed said it’s “prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments.” The central bank also said it would be ready to alter the balance sheet’s size and composition if the economy warrants a looser monetary policy than the federal funds could achieve on its own.
The statements mark a broader shift toward risk management. The FOMC dropped previous language calling for “some further gradual increases” in interest rates and opened the door for the next move to be either up or down, as it cited “global economic and financial developments and muted inflation pressures.” Policy makers also omitted a line saying risks to the outlook are “roughly balanced.”
The decision comes after Chairman Jerome Powell’s remarks earlier in January assuring that officials will be patient in raising rates helped to calm investors, who had perceived he was overly dismissive of sharp stock drops and volatility. Powell will address reporters at 2:30 p.m.
In another significant move, the committee said will continue to run monetary policy in an ample-reserve regime, where control over short-term interest rates “is exercised primarily through the setting of the Federal Reserve’s administered rates, and in which active management of the supply of reserves is not required.” That suggests the FOMC has will set policy with a larger balance sheet than would be the case if it went back to its pre-crisis approach.
The unanimous 10-0 decision held the target range for the federal funds rate at 2.25 percent to 2.5 percent. Powell’s press conference on Wednesday inaugurates a new approach of briefing the media after every meeting of the FOMC — eight times a year — instead of every other meeting. Policy makers will still update economic projections quarterly.
The statement was in line with the views of more than two-thirds of economists surveyed by Bloomberg News last week, who said the Fed wouldn’t keep the language on “some further gradual increases” and would instead signal greater uncertainty, refer to patience or remove the line entirely.
Officials gathered in Washington with less visibility on the economy after a five-week government shutdown delayed the release of some statistics including December retail sales and fourth-quarter gross domestic product.
Even without a full flow of data, the Fed said household spending “has continued to grow strongly” while business investment growth had moderated since earlier in 2018. The committee said economic activity “has been rising at a solid rate” and job gains have been strong. There was no reference to the shutdown.
As the central bank does every January now, the Fed also published a separate statement on its longer-run goals and policy strategy. The statement reaffirmed the central bank’s 2 percent inflation target, and again stressed its symmetry, meaning it would be concerned if it persistently ran above or below that target.
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.