FOMC Minutes Signal “Gradual Approach” To Raising Rates

by Ike Obudulu Posted on October 17th, 2018

Washington, D. C., USA: The minutes of the FOMC September monetary policy meeting showed members continue to favor a “gradual approach” to hiking rates, amid recent concerns the Federal Reserve may raise interest rates more aggressively than currently anticipated.

The assessment that the “gradual approach” remains appropriate comes as the meeting participants generally judged that the economy was evolving about as anticipated.

The Fed argued the “gradual approach” would balance the risk of raising rates too quickly, causing a slowdown in the economy, and raising rates too slowly, leading to inflation above the central bank’s 2 percent objective.

Looking ahead, the minutes said a few meeting participants expected rates would need to become modestly restrictive for a time.

A number of participants also determined it would be necessary to temporarily raise rates above the longer-run level in order to reduce the risk of a sustained overshooting of the Fed’s inflation target.

Meanwhile, a couple of participants indicated they would not favor adopting a restrictive policy stance in the absence of clear signs of an overheating economy and rising inflation.

The minutes also said members judged that information received since the last Fed meeting in August indicated that the labor market had continued to strengthen and that economic activity had been rising at a strong rate.

Both overall inflation and core inflation remained near 2 percent, while indicators of longer-term inflation expectations were little changed on balance, the minutes said.

The Fed added that members continued to believe that the risks to the economic outlook remained roughly balanced.

During the meeting, the Fed decided to raise rates by a quarter point for a third time this year to 2 to 2.25 percent and forecast another rate hike before the end of the year. The central bank’s forecasts also pointed to three rate hikes in 2019.

The Fed’s assessment that the “gradual approach” to raising rates remains appropriate comes even as President Donald Trump has repeatedly attacked the central bank for hiking rates too quickly.

Trump continued his assault on the Fed in an interview on Tuesday, calling the central bank the “biggest threat” to his presidency.

“My biggest threat is the Fed,” Trump said during an interview with Fox Business’ Trish Regan. “Because the Fed is raising rates too fast.”

Noting the central bank’s independence, Trump said he has not spoken to Fed Chairman Jerome Powell but added, “I’m not happy with what he’s doing.”

The Federal Reserve downplayed any disruption to its policy tools from a drop last month in the so-called excess reserves that flow among banks

Since the Fed began shrinking its balance sheet a year ago, it has shed some $250 billion in bonds accumulated to help the economy recover from recession. Over the same time, bank reserves dropped by more than twice that value, which has encouraged an upward creep of the Fed’s main policy rate within a defined range, currently set at 2.00-2.25 percent.

The U.S. central bank is currently paying a 2.20 percent interest rate on excess bank reserves (IOER).

In September, this knock-on effect was exacerbated by a jump in tax receipts flowing into the U.S. Treasury Department’s account at the Fed.

The minutes described last month’s dip as sharp but temporary. However “that reduction in reserves in the banking system did not seem to have any effect on the federal funds market,” according to the manager of the Fed’s portfolio, who gave a presentation during the meeting.

The federal funds policy rate has crept up to within 0.03 percent – or 3 basis points – of its ceiling within the range. “That spread stood at 3 basis points over much of the period and seemed likely to narrow to 2 basis points in the near future,” the minutes said.

In late September, the difference between IOER and the daily average fed funds rate narrowed to 2 basis points before widening out to 3 basis points.

Market Reaction

Wall Street’s major indexes slipped on Wednesday after the Federal Reserve released meeting minutes showing broad agreement on the need to raise borrowing costs further, cementing investor concerns that had helped cause a major sell-off the week before.

The Dow Jones Industrial Average .DJI fell 92.48 points, or 0.36 percent, to 25,705.94, the S&P 500 .SPX lost 0.74 points, or 0.03 percent, to 2,809.18 and the Nasdaq Composite .IXIC dropped 2.79 points, or 0.04 percent, to 7,642.70.

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.

Author

Ike Obudulu

Ike Obudulu

Versatile Certified Fraud Examiner, Chartered Accountant, Certified Internal Auditor with an MBA in Finance And Investments who has both worked for and consulted with some of the world's largest companies on main street and wall street in over 20 countries, Ike brings his extensive reporting and investigations experience to bear on his role as Chief Editor.
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