Washington, D. C., USA: The Federal Reserve is ready to raise interest rates again so long as the economy stays on track, according to recent policy meeting minutes – signaling broad support for another interest-rate hike in September.
“Many participants suggested that if incoming data continued to support their current economic outlook, it would likely soon be appropriate to take another step in removing policy accommodation,” minutes of the July 31-Aug. 1 Federal Open Market Committee meeting released Wednesday in Washington said.
The minutes said that “further gradual increases” in their target rate “would be consistent with a sustained expansion of economic activity, strong labor market conditions and inflation near the committee’s symmetric 2 percent objective over the medium term.”
They debated the impact of the fiscal stimulus with some noting “larger or more persistent positive effects” as a potential upside risk.
“All participants pointed to ongoing trade disagreements and proposed trade measures as an important source of uncertainty and risks,” the minutes said.
The staff gave a presentation on the lower boundary on interest rates and alternative policy tools. Participants emphasized there was “considerable uncertainty” about the economic effects of unconventional tools, the minutes said, and agreed to continue studying the topic at future meetings.
The staff forecast continued to project that the economy would grow “at an above-trend pace.” Staff economists also “continued to assume that the projected decline in the unemployment rate would be attenuated by a greater-than-usual cyclical improvement in the labor force participation rate,” the minutes said.
Data showing a robust U.S. labor market with inflation around the central bank’s 2 percent target have solidified investor expectations of another hike at their meeting next month.
The Federal Reserve minutes was expected to illuminate it’s outlook for interest rates next year. That conversation, along with any hints about how they are judging progress as they unwind part of the Fed’s $4.2 trillion balance sheet, was the main focus for investors when minutes of the policy-setting Federal Open Market Committee’s July 31-Aug. 1 meeting were released.
Minutes of the FOMC’s previous meeting, published in early July, revealed that committee participants in June “offered their views about how much additional policy firming would likely be required,” but the account didn’t provide a summary of what those views were.
The benchmark federal funds rate is currently fluctuating in a range between 1.75 percent and 2 percent, and investors expect the FOMC to authorize two more quarter-point increases before the year is out, according to futures contracts.
Such a path would put the committee on track to reach a “neutral” level for rates — the theoretical level which would neither stimulate nor restrict growth — sometime next year. Most on the FOMC believe that level is somewhere between 2.5 percent and 3 percent, according to estimates published in June.
The question hinted at toward the end of the June meeting minutes is what to do once the committee gets to neutral. Does it keep raising rates in order to preempt inflation, or does it stop there, while taking comfort in signs that inflationary pressures are contained?
So far, the interest-rate projections suggest the FOMC is leaning toward the first option. The median estimate in June was for rates of 3 percent to 3.25 percent by the end of 2019, and between 3.25 percent and 3.5 percent the following year.
Those projections reflect policy makers’ expectations that unemployment, currently at 3.9 percent, will stay below their estimate of the so-called “natural rate” of unemployment that would keep inflation stable, which in June they believed to be at 4.5 percent.
But some Fed officials have been critical of the plan, and Powell has not revealed which way he is leaning — though he said during congressional testimony in July that “for now,” gradual rate hikes continued to be appropriate.
President Donald Trump is also complicating matters. He reportedly told Republican donors at an Aug. 17 fundraiser that he did not appreciate rate hikes, building on comments he offered last month.
The debate about what to do with interest rates next year “will definitely be part of the conversation” in the minutes, but references to Trump probably won’t be, said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York.
“What the president wants in this instance is directly contrary to what is the governing principle for the Fed, and so I think the Fed will be true to its foundational elements,” Porcelli said. “The Fed is supposed to raise rates north of neutral if economic activity is accelerating and they are worried about the potential for overheating. That’s the job.”
June’s minutes also said a few officials advocated a more in-depth conversation “before too long” about the game plan for the Fed’s balance sheet, which they began unwinding earlier this year. That may not have taken place at the last meeting, but the minutes could preview how that discussion will go.
Fed officials say they still don’t know how far they will be able to shrink the balance sheet. It ballooned to $4.5 trillion after years of bond purchases in the wake of the financial crisis, which created a pile of cash reserves held by banks on deposit at the Fed.
But policy makers are watching the federal funds rate for clues — as reserves become increasingly scarce it should rise — and the recent upward drift of the rate within the quarter-point target range the FOMC sets for it has some analysts predicting there may not be much further to go.
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.