Washington, D. C., USA: The minutes of the FOMC October monetary policy meeting showed members, almost all Fed officials, saw a rate hike warranted “fairly soon” while setting the stage for more flexibility in their series of gradual hikes.
“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,’’ assuming the economy performs in line or stronger than their expectations, the central bank said in the minutes of its Nov. 7-8 session released in Washington Thursday.
Officials also said that their post-meeting statement may need to be modified at coming meetings, “particularly the language referring to the committee’s expectations for ‘further gradual increases,”’ the minutes said.
The minutes reinforce comments by Chairman Jerome Powell on Wednesday that suggested central bankers are getting close to an estimated range of interest rates that neither speed up nor slow down growth and are now adopting a flexible approach to their policy path. Those remarks sparked a rally in stock and bond markets, while sending the dollar lower.
At the meeting this month, U.S. central bankers left the benchmark lending rate in a range of 2 percent to 2.25 percent. Fed officials next meet Dec. 18-19, and futures traders are pricing in a more than 70 percent probability of another quarter-point increase in the range for the benchmark lending rate, which would be the fourth hike of 2018.
A December increase would bring the policy rate close to the bottom of the 2.5 percent to 3.5 percent range policy makers estimated as neutral. At the same time, Fed officials are emphasizing they are becoming increasingly reliant on indicators and data to tell them that they are getting close to neutral.
“Many participants indicated that it might be appropriate at some upcoming meetings to begin to transition to statement language that placed greater emphasis on the evaluation of incoming data in assessing the economic and policy outlook,” the minutes said. “Such a change would help to convey the committee’s flexible approach.”
While Fed officials expected solid growth to continue before slowing to a pace closer to its trend over the medium term, they still saw some risks. The buildup of corporate debt amid weakening lending standards caught the attention of the committee.
“Several participants were concerned that the high level of debt in the nonfinancial business sector, and especially the high level of leveraged loans, made the economy more vulnerable to a sharp pullback in credit availability,” the minutes said.
The minutes also contained a lengthy discussion of the Fed’s operating strategy and how that links to banks’ preference to hold abundant excess reserves after the financial crisis.
Following a staff presentation which included a survey of senior financial officers, Fed officials appeared to side in favor of an operating regime that would provide abundant reserves to banks through a large Fed balance sheet, meaning that the central bank’s portfolio is unlikely to return to its pre-crisis stance.
“Based on experience over recent years, such a regime was seen as providing good control of short-term money market rates in a variety of market conditions,” the minutes said. “By contrast, interest rate control might be difficult to achieve in an operating regime of limited excess reserves.”
The minutes flagged the possibility that the Fed will make another adjustment to maintain control of the policy rate, by adjusting the separate interest rate on excess reserves, or IOER, which is currently set at 5 basis points below the upper bound of the federal funds target range.
Powell was cited in the minutes as saying that “it might be appropriate to implement another technical adjustment in the IOER rate relative to the top of the target range for the federal funds rate fairly soon.” Fed officials agreed that it would be “appropriate” to take action before the December meeting if necessary to keep the federal funds rate “well within” the Fed’s target range, according to the minutes.
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.