Washington, D. C., USA: The Federal Open Market Committee, FOMC, announced its decision to raise interest rates by a quarter point on Wednesday – in a widely expected move. The federal reserve said its Federal Open Market Committee decided to raise the target range for the federal funds rate by 25 basis points to 2.25 percent to 2.50 percent.
The Fed’s closely watched accompanying statement noted the labor market has continued to strengthen and that economic activity has been rising at a strong rate.
Annual rates of both overall inflation and core inflation were also said to remain near the Fed’s 2 percent target, with indicators of longer-term inflation expectations also little changed.
The Fed also reiterated that further gradual increases in interest rates would be consistent with the FOMC’s mandate to foster maximum employment and price stability.
However, eagle-eyed Fed watchers will notice the inclusion of the word “some” in the statement regarding further gradual rate increases.
In another indication the Fed plans to raise rates less than previously anticipated, the central bank’s projections point to two rate hikes in 2019 compared to the previous forecast for three.
The Fed’s median projection for the federal funds rate in 2019 was reduced to 2.9 percent from the 3.1 percent expected in September.
The central bank also lowered its forecasts for real GDP growth in 2018 and 2019 to 3.0 percent and 2.3 percent, respectively. The Fed previously projected 3.1 percent growth in 2018 and 2.5 percent growth in 2019.
While once again calling risks to the economic outlook roughly balanced, the Fed added that it will continue to monitor global economic and financial developments and assess their implications for the economic outlook.
The decision stands to affect rates on all kinds of borrowing, from home mortgages to credit cards. The 30-year mortgage rate in the past year climbed from 3.95 percent to a peak of nearly 5 percent in November — a seven-year high. It has since dropped to 4.63 percent.
The Fed last raised rates in September. Since then, the U.S. economy has given off mixed signals. The job market remains strong, with unemployment at the lowest level in nearly 50 years. Growth clocked in at a solid 3.5 percent in the third quarter.
But the stock market has tumbled sharply in recent months. Car and home sales have slumped as interest rates have climbed. And ongoing trade tensions between the United States and China have led to growing fears about the outlook for the global economy.
President Trump has regularly criticized the Fed on Twitter in recent weeks.
It is incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris is burning and China way down, the Fed is even considering yet another interest rate hike. Take the Victory! — Donald J. Trump (@realDonaldTrump) December 17, 2018
Trump’s complaints about the Fed haven’t been limited to Twitter. He called the Fed his “greatest threat” in October in an interview with Fox Business, and has singled out Fed chairman Jerome Powell for pointed attacks.
Such criticism is unusual — the Fed is expected to be insulated from political pressure. Presidents in recent times, including Trump’s predecessors, Barack Obama and George W. Bush, have refrained from overtly criticizing the independent central bank.
Powell has said that the economic outlook remains solid and that interest rates are nearly within a “neutral” range — indicating that the Fed may not be immediately worried about inflation.
“Interest rates are still low by historical standards,” he said in November.
Powell has not responded to the barrage of attacks from President Trump and there is no evidence he plans to deviate from the Fed’s plan to gradually raise rates. That perspective was evident in the minutes from the central bank’s November meeting: “Almost all participants expressed the view that another increase in the target range for the federal funds rate was likely to be warranted fairly soon.”
But stock prices have fallen sharply since early November. And it is somewhat rare for the Fed to raise rates in the face of a sustained market selloff. So there’s an outside chance the Fed could change course and pull a stunner by keeping rates steady at the Wednesday meeting. The would be a big surprise with lots of unpredictable consequences.
Some policymakers say that with unemployment so low, the Fed should raise interest rates even more to head off inflation, while others say the Fed needs to slow down.
Even former Federal Reserve economist Ann Owen has noted that the sweet spot of low unemployment and low inflation has economists at the Fed wondering.
“Do you want low and stable inflation, or do you want really rapid inflation because that would confirm your belief about how the economy works?” Owen said in October. “I have to believe that most of the people at the Fed would say, give me low and stable inflation.”
The Treasuries yield curve flattened after the Federal Reserve raised interest rates for a fourth time this year but pared projections for hikes in 2019, in a signal that officials may soon pause their policy tightening.
The spread between 2- and 10-year Treasury yields sank below 13 basis points as benchmark 10-year Treasuries rallied after policy makers revised their so-called dot plot from projecting three hikes next year to two. The dollar index trimmed daily losses to 0.1 percent, after earlier falling as much as 0.4 percent.
Wall Street forecasters had anticipated that the Fed would lower the 2019 median dot. Investor confidence in the Fed’s tightening path has crumbled in recent weeks amid tumbling stocks and doubts about global growth. Policy makers also lowered where they see the neutral rate in the long run to 2.75 percent.
“Surprisingly, they lowered the long-term dot,” said Michael Collins, senior portfolio manager at PGIM Fixed Income. “If the funds rate is going to average 2.80 over the next 10 years rather than 3 percent, that should theoretically lower the 10-year rate. That’s a curve flattener in our mind.”
Fed funds futures now show about 14 basis points of Fed tightening priced in for 2019.
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.