FOMC Meeting: What You Need to Know
The Federal Open Market Committee, also known by the acronym ‘FOMC’, is the twelve-member committee within the United States Federal Reserve responsible for determining monetary policy. Accordingly, their decision-making process is highly anticipated by market participants and consumers alike.
The FOMC concluded its latest and third summit of the year yesterday, Wednesday, May 3, 2023, with yet another interest rate hike. On the one hand, the Fed’s hawkish monetary policy comes at a time when some economic data, like the latest U.S. Personal Consumption Expenditures Index (PCE), seems to suggest that inflation has been cooling off a tad. On the other hand, other economic indicators like the advanced estimates for U.S. Q1 GDP may have shown that inflation still remains stubbornly high.
Moreover, it is no secret that the economy as a whole has been struggling to cope with higher rates as major big tech companies have been laying off employees and big banks have been collapsing. Prior to the summit, some analysts even stated that this is “a pivotal meeting” and explained that if the Fed hikes rates by another 25 basis points then the fed-funds rate would reach its highest range since 2007.
As such since the Fed stuck to the expected 25 basis point hike amidst all of the market uncertainty, understanding how this central bank functions and how the markets have reacted to rate hikes is crucial to grasping the state of the U.S. and the global economy. Here’s what you need to know about the Fed’s latest meeting:
What Is Monetary Policy?
Monetary policy denotes the moves taken by a nation’s central bank, in this case, the Federal Reserve, to ‘move the needle' with regard to the availability and cost of cash and credit. There are three main levers the Federal Reserve of the United States utilizes to enact monetary policy: the discount rate, bank reserve requirements, and open market operations (OMO); the Federal Open Market Committee is responsible solely for the latter.
What Are Open Market Operations and How Are They Used?
Open Market Operations are the sale and purchase of government-backed Treasuries and securities on the market. The federal funds rate, which is set by the Fed’s Board of Governors, is the rate of interest for overnight loans that American banks charge each other; this rate also serves as a benchmark for mortgage rates, interest on credit cards, and more. The interest rate banks charge each other is crucial, because interbank loans enable banks to keep their cash reserves high enough to satisfy consumer demand for loans.
The FOMC uses Open Market Operations as its main tool to ‘push’ the market to that target federal funds rate. When Treasuries and other securities are purchased, using freshly-printed money, the money supply on the market increases, and the interest rate banks charge each other for overnight loans goes down. The money supply falls, and interest rates rise, when the FOMC makes the decision that the Federal Reserve should sell Treasuries and securities that it is currently holding.
The monetary track embarked on by the Federal Reserve is vital, because Treasuries are bought and sold by the Fed in such large quantities that they directly influence the overall interest rates available to banks and everyday consumers alike. When more securities are purchased, the supply of money available in U.S. bank reserves rises, so loans become easier to obtain and interest rates decrease.
How Does the FOMC Decide What Road to Take?
Depending on the overall economic climate, and the FOMC members’ assessment thereof, the FOMC determines whether the Federal Reserve will either buy or sell government-backed securities.
In times of economic strife, the FOMC tends to recommend buying securities in order to support economic growth; the inverse is true when the national economy seems to be on more stable ground. However, given that economic judgments are not always objective, there can sometimes be disagreements within the FOMC.
Many factors go into the FOMC’s ultimate determination; members review overall economic indicators such as inflation, unemployment, and GDP. In addition, they may even consider how a change in monetary policy could affect specific industries within the American marketplace.
The FOMC Meeting minutes, which provide a detailed summary of the discussion conducted between committee members, reveal exactly which factors lead to the Fed’s monetary policy decisions, as well as the various members’ views. While a press conference is conducted shortly after the FOMC meeting ends, the minutes are not released for a full three weeks following the meeting’s conclusion, so much of what goes into the committee’s decision remains a mystery to the public for nearly a month afterward.
Furthermore, to understand how the Fed operates better, it may be worth keeping in mind ‘hawkish vs. dovish’ monetary jargon which is used to describe the different Fed monetary stances. Accordingly, FOMC members can often be referred to as ‘hawkish’, those favoring less bond-buying, ‘dovish’, who take the opposite view, or ‘centrists’, whose approach lies somewhere in between. The relative proportion of those holding each view has important repercussions for how the Federal Open Market Committee functions. Following this logic, in the past few months, given the fact that the Fed and other central banks consistently hiked interest rates to tame inflation, many described the Fed’s monetary policy as hawkish. Some analysts even claim that the latest rate hike “is about as hawkish as the Fed can be given the banking sector stresses that are ongoing.”
How Does the FOMC Operate?
Eight times a year, or more depending on necessity, the committee holds a meeting to decide on the course of federal monetary policy in the near-term. At the meeting, held in Washington, D.C., committee members will review the nation’s macroeconomic conditions, assess risks, and determine the direction best suited to the FOMC’s goals of keeping prices stable along with an overall sustainable rate of economic growth. The twelve members then vote on whether buying or selling securities is more likely to attain these goals. The meeting, which began Tuesday, May 2nd, and concluded Wednesday, the 3rd of May, with a press conference, was the committee’s third meeting of the year.
Who Sits on the FOMC Committee?
Of the twelve members of the FOMC, seven are Federal Reserve Board of Governors members. The Board of Governors’ chair serves as the FOMC’s chair concurrently. The members of the Board of Governors are appointed by the U.S. President and serve for fourteen years on the board.
The Federal Reserve Bank of New York’s president, since 2018, John C. Williams, is a perpetual member of the committee. Four of the remaining eleven regional Federal Reserve Bank presidents also serve on the FOMC in one-year rotations to ensure representation from all regions of the United States. (Source:Investopedia)
How Does the Fed Influence the U.S. Economy?
When the Federal Reserve moves to increase interest rates, it can have an outsize effect on the economy as a whole. If the FOMC moves to sell securities, thus increasing the federal funds rate and interest rates across the economy, various firms’ assessment of their future revenue flows can be negatively affected, as debt expenses will grow.
If investors believe that debt servicing could have a negative effect on a company’s revenue growth, they’ll be less inclined to buy that company’s stock, the price of which will fall. The financial sector, conversely, stands to gain from an interest rate rise, since they’ll then be able to gain more from lending fees.
How Is the Stock Market Responding?
Following the Fed’s rate decision to hike interest rates further in the battle against inflation, volatility materialized across the various market sector. This may be due to Powell’s remarks in which he stated that the Fed believes “that inflation is going to come down not so quickly.” In addition, he explicitly stated that the Fed will not cut rates any time soon as he said that “It will take some time, and in that world, if that forecast is broadly right, it would not be appropriate to cut rates and we won’t cut rates.”
Accordingly, at a time when tension and uncertainty are at an all-time high, the Fed chair’s remarks coupled with the rate hiking decision may have caused some traders and investors to shy away from the markets. As a result, major Wall Street indices like the tech-heavy Nasdaq (US-TECH 100), the S&P 500 (USA 500), and the Dow Jones Industrial Average (USA 30) all slid by 0.46%, 0.70%, and 0.80% on Wednesday.
Furthermore, banking stocks, which were already suffering in the past few months also closed the day in the red after Powell revealed that while the banking crisis may be over, its effects will continue to send ripples across the markets for a while. Regional banks like Zions Bancorporation (ZION) fell by 4.6% that day and big banks like JPMorgan (JPM) and Citigroup (C) fell by 2.1% and 0.7% on Wednesday.
In recent months, global indices and commodities have been hit by drastic dips and rises, making the economy’s near-term trajectory hard to predict. Jerome Powell and the members of the FOMC have quite a dilemma on their hands: how can record-high inflation be battled without causing a general recession? Will high employment be maintained in an environment of monetary tightening? With the global geopolitical situation so unstable, how reliably can market movements be predicted? The Federal Reserve’s top brains will have to balance their urge to stabilize rapid price increases across the American economy with a patently unstable global state of affairs.
All in all, as of now, it seems that the Fed has chosen the more hawkish road in an attempt to tackle the aforementioned hurdles. Traders, investors, and analysts alike may want to keep a keen eye on the market movements and track other major economic releases in order to see if any substantial changes materialize and understand the broader market better.