Washington, D. C., USA: The minutes of the FOMC December monetary policy meeting showed members took a more cautious approach to further rate increases than their statement indicated.
“Many participants expressed the view that, especially in an environment of muted inflation pressures, the committee could afford to be patient about further policy firming,’’ the central bank said in minutes of its Dec. 18-19 policy meeting released Wednesday in Washington.
The vote to hike rates was unanimous but the minutes showed “a few participants” favored no change. The minutes showed the committee was attentive to recent financial-market volatility and risks to the outlook.
“Participants expressed that recent developments, including the volatility in financial markets and the increased concerns about global growth, made the appropriate extent and timing of future policy firming less clear than earlier,” the minutes said.
Officials signaled that further gradual increases in the policy rate were likely, though several participants said that it might be appropriate “over upcoming meetings to remove forward guidance entirely.” They suggested replacing it with language emphasizing “the data-dependent nature” of monetary-policy decisions.
The meeting was the most significant of Jerome Powell’s chairmanship so far. Officials raised rates and projected two more hikes in 2019, ignoring President Donald Trump’s demands for a halt and steep losses in the stock market, which deepened following their decision.
The minutes showed that officials voting at the meeting included language referring to “some further gradual” increases to indicate that they “judged that a relatively limited amount of additional tightening likely would be appropriate.”
Last month became the worst December for U.S. stocks since the Great Depression, with the rout continuing after Bloomberg News reported that Trump had discussed firing Powell. There was no direct reference to Trump in the minutes.
Officials agreed that policy was not on a pre-set path. “If incoming information prompted meaningful reassessments of the economic outlook and attendant risks, either to the upside or the downside, their policy outlook would change,” the minutes said.
Participants discussed five distinct downside risks to the outlook, including: a sharper-than-expected decline in global growth; a faster fading of fiscal stimulus; heightened trade tensions; further tightening of financial conditions; and a greater-than-expected negative impact from monetary policy tightening so far.
For upside risks, participants noted that the effects of stimulus could be larger than expected, that uncertainties around global growth and trade tensions could be resolved favorably, while citing conditions that could lead to stronger inflationary pressures.
“In general, participants agreed that risks to the outlook appeared roughly balanced, although some noted that downside risks may have increased of late,” the minutes said.
U.S. central bankers forecast above-trend growth for 2019 and that unemployment will fall further.
The minutes also noted monetary policy is not on a “preset course,” with participants emphasizing that the approach to setting the stance of policy should be importantly guided by the implications of incoming data for the economic outlook.
Notably, the Fed’s projections provided after the meeting pointed to two interest 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 minutes revealed participants generally revised down their individual assessments of the appropriate path for monetary policy after taking into account incoming economic data, information from business contacts, and the tightening of financial conditions.
Participants still determined that some further gradual increases in rates would most likely be consistent with achieving the Fed’s dual mandate.
At the meeting, the Fed decided to raise interest rates by 25 basis points to a range of 2.25 percent to 2.50 percent, as participants generally judged that the economy was evolving about as anticipated.
“A few participants, however, favored no change in the target range at this meeting, judging that the absence of signs of upward inflation pressure afforded the Committee some latitude to wait and see how the data would develop,” the minutes said.
CME Group’s FedWatch tool currently indicates a 99.5 percent chance the Fed will leave interest rates unchanged at its next meeting later this month.
Since the meeting, Fed officials have assured investors that their outlook for higher rates depends on the economy performing as expected.
Powell said Jan. 4 he was “listening sensitively to the message that markets are sending” about downside risks. The dovish tone of his comments, plus a strong December payroll report, helped stocks rally 3.4 percent on the day.
U.S. central bankers held another wide-ranging discussion on their balance sheet without committing to a strategy. They discussed the possibility of ending portfolio redemptions with “a relatively high level of reserves” and also the possibility of “very gradual” mortgage-backed securities sales once the portfolio hit a more normal level. They also debated the best maturity profile for the portfolio, with several participants leaning toward a balance sheet with shorter maturities.
Some investors have blamed the shrinking balance sheet for causing turbulence in financial markets. Trump also appeared to refer to the runoff in a Dec. 18 tweet in which he urged the central bank to “Stop with the 50 B’s. Feel the market.’’
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.