FOMC minutes signal continuation of patient approach to rates

by Ike Obudulu Posted on May 22nd, 2019

Washington: Members of the Federal Reserve are in no rush to alter the path of interest rates, according to the minutes of the central bank’s latest monetary policy meeting.

The minutes showed members agreed that a patient approach to determining future adjustments to rates would likely remain appropriate for “some time.”

Citing an environment of moderate U.S. economic growth and muted inflation pressures, the Fed expects to remain patient even if global economic and financial conditions continued to improve.

The Fed decided to leave interest rates unchanged at the two-day meeting ended May 1st, as uncertainties affecting the U.S. and global economic outlooks had receded but inflation pressures remained muted.

The minutes showed members agreed future interest rate adjustments would be based on realized and expected economic conditions relative to the Fed’s maximum-employment and symmetric 2 percent inflation objectives.

While the Fed noted a moderation in risks and uncertainties surrounding the economic outlook, such as trade negotiations, the meeting was held before the collapse of U.S.-China trade talks.

The central bank is scheduled to hold its next monetary policy meeting on June 18th and 19th, with CME Group’s FedWatch tool currently indicating a 95 percent chance the Fed will leave rates unchanged.

Portfolio Discussion

The staff analysis showed that a move to the shorter-term portfolio “would put significant upward pressure on term premiums and imply that the path of the federal funds rate would need to be correspondingly lower to achieve the same macroeconomic outcomes as in the baseline outlook,” the minutes said.

In their discussion of a portfolio proportional to the Treasury market, “participants observed that moving to this target” of portfolio composition “would not be expected to have much effect on current staff estimates of term premiums and thus would likely not reduce the scope for lowering the target range for the federal funds rate target in response to adverse economic shocks.”

Several participants judged that the proportional approach would be “well aligned with the committee’s previous statements that changes in the target range for the federal funds rate are the primary means by which the committee adjusts the stance of monetary policy.” At the same time, some of the debate focused on how much capacity each strategy would allow for adding economic stimulus through a maturity extension program.

Investors have been betting the Fed will cut interest rates later this year partly on concern over inflation running persistently below its 2% target, which prices have done for most of the last seven years.

On the economic outlook, “many participants suggested that their own concerns from earlier in the year about downside risks from slowing global economic growth and the deterioration in financial conditions or similar concerns expressed by their business contacts had abated,” according to the minutes.

GDP expanded at a 3.2% annual pace in the first quarter, surpassing expectations, and unemployment hit a 49-year low in April. The U.S. expansion is on track to become the longest on record in July.

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