Washingoton, DC, USA: Following today’s conclusion of its two-day meeting, the Federal Open Market Committee (FOMC), announced a 25 basis point (bps) federal funds target interest rate increase in it’s policy statement released at 2 pm ETD.
The Federal Open Market Committee also voted to continue the process of balance sheet normalization, which it began in October. It will continue to shrink it’s bond portfolio. Two members of the committee, Neel Kashkari and Charles Evans, voted against the decision, preferring not to raise rates.
The change of the target range for the 30-day federal funds rate to 1.25-1.50%, from 1.00-1.25%. was well telegraphed by the Fed, so it is already entirely priced in by investors.
Following the release of the FOMC statement, the Fed Chair, Janet Yellen will be holding a press conference as well. The economic projections will be released which will give the market insights into the Fed’s forecasts for the next quarter.
This also included the dot plot which will see the Fed officials’ estimates on where interest rates could be in the year ahead. The markets were expecting to see the Fed signal at least three rate hikes next year. This could potentially mean that U.S. interest rates will rise to 2.25% by end of 2018.
It will be her last before her four-year term ends early next year. Since she will leave the Fed in early February, her words may not carry the weight that they had previously.
Markets now focus on the Fed’s economic forecast along with the “Dot Plot” interest-rate forecasts which provides guidance on future rate increases.
The rate decision itself shouldn’t provide much of a boost for the dollar, however with the statement and new economic projections, including the dot plot, being released alongside it, there could be plenty of volatility.
This December’s rate hike, now a done deal, will be the third rate hike this year. The Fed had previously estimated three rate hikes this year at the start of the year.
The Fed started to tighten monetary policy in December 2016, lifting interest rates for the first time from historic lows of 0.25%. This came after the Fed lowered interest rates and launched its Quantitative easing (QE) program in response to the 2008 global financial situation.
The central bank is also expected to continue with its balance sheet normalization program that began in October. The pace of unwinding is also expected to increase starting January 2018.
The Fed has penciled in another possible three hikes for next year and two more for 2019 before topping out near +2.75%.
Since the Fed is repeating three hikes in 2018 in the dot plot, don’t expect any major reaction in the market pricing.
Four hikes in the dot plot would have propelled both short-term pricing and the 10 year treasury yield higher
Projections for the total number of expected rate hikes in 2018 remained unchanged with three quarter-point raises next year. Officials also forecast the fed funds rate will reach 3.1% in 2020, just above its long-run goal of 2.8%.
The Fed’s expectations for GDP growth increased slightly to 2.5% in 2018. Meanwhile forecasts for core PCE inflation remained unchanged, while officials predict unemployment will hit 4% in 2020, below the long-run goal of 4.6%.
Overnight, the dollar managed to halt its longest winning streak in nearly two-years after the Democratic candidate, Doug Jones, won the Alabama Senate race, cutting the Republican majority in the U.S senate in half.
Yesterday’s Alabama Senate result was a loss for congressional Republicans because it trims their Senate advantage to 51-49 as they enter some tough negotiations on spending with Democrats next year. However, it probably will not affect the expected vote on Trump’s supposed business-friendly tax cuts, as the winner will not be certified until late December and sworn in in January. Republicans are hoping to get a bill passed through both sides of Congress before Christmas.
Equity markets in the US opened flat ahead of the FOMC decision.
Chair Janet Yellen’s successor, Fed Governor Jerome Powell, said at his recent confirmation hearing before a Senate panel that he had “no sense of an overheating economy,” an early signal he may not want to quicken the pace of rate increases until there is evidence of an acceleration in wage growth and inflation.
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.
UPDATE: “At the moment, the U.S. economy is performing well,” Fed Chairwoman Janet Yellen said at a press conference Wednesday, after the Fed’s two-day policy meeting.
“The growth that we’re seeing, it’s not built on, for example, an unsustainable buildup of debt,” she added. “The global economy is doing well. We’re in a synchronized expansion. This is the first time in many years we’ve seen this…I feel good about the economic outlook.”
New projections show officials expect the economy to grow at a 2.5% rate this year and next, up from September projections of 2.4% and 2.1%, respectively. The Fed still expects the economy will grow at 1.8% over the long run, and Wednesday’s projections show officials now expect economic growth will surpass that level through 2020.
Officials didn’t change their forecasts significantly around inflation, even though they now project the unemployment rate to fall to 3.9% in 2018 and 2019, down from prior forecasts of 4.1% and below the level that they expect should prevail over the long run, which was unchanged at 4.6%.
In its postmeeting statement, the Fed’s rate-setting committee described the job market as strong. “The committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong,” the statement said.
Ms. Yellen said during her postmeeting press conference that officials continue to expect the economy to expand at a moderate pace, adding that “while changes in tax policy will likely provide some lift to economic activity in the coming years,” the magnitude and timing of the boost to growth remains uncertain.
She said most Fed officials had incorporated some fiscal stimulus from the emerging tax package into their updated economic projections, but some had done so already in their previous estimates earlier this year.
Even so, she said, officials concluded that monetary policy doesn’t need to change significantly. “We continue to think…a gradual path of interest rate increase remains appropriate,” she said.
She cautioned that the new projections shouldn’t be taken as estimates of the economic impact of a tax overhaul, stressing that “considerable uncertainty” about the effects remain.
Fed officials would welcome tax changes that boosted the economy’s growth potential as long as that coincided with the central bank’s ability to achieve its goals of full employment and stable, low inflation.
Ms. Yellen added that she remained concerned over federal budget deficits that are projected to grow as the baby boom ages, even before the added effect of tax cuts. “This is something I’ve been saying for a long time. I am personally concerned about the U.S. debt situation,” she said. “Taking what is already a significant problem and making it worse, it is a concern to me.”
Ms. Yellen also said she worried higher deficits now could limit the scope for fiscal policy makers to respond aggressively to an economic downturn in the future.