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. The FOMC concluded its latest summit yesterday, February 1st, with the decision to raise interest rates by 25 basis points, or 0.25%, despite a recent slowdown in inflation. With the U.S. central bank continuing to hike interest rates skyward in the battle against inflation, some may be wondering how this could affect the economy as a whole. Let’s take a look at how the FOMC formulates policy decisions and how they play out on the markets:

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 afterwards.

FOMC members can often be referred to as ‘hawkish’, those favouring 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 on how the Federal Open Market Committee functions.

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, January 31st, and concluded yesterday afternoon, the 1st of February, with a press conference, was the committee’s first of the year. (Source:Investopedia)

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.

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. Institutions like Bank of America (BAC) and Morgan Stanley (MS) may already be calculating how best to grapple with the benefits and challenges presented by higher interest rates.  Furthermore, during times of inflationary pressure accompanied by higher interest rates, investors and traders tend to shy away from tech stocks and usually opt for safe-haven assets instead. It might explain the layoffs, hiring freezes, and challenges in the tech industry throughout the year.

How Is the Stock Market Responding?

February 1st, 2023, may have marked a watershed moment in the continuing saga of the American central bank’s fight against inflation. While this is the eighth time in the past year that the Federal Open Market Committee has moved to hike interest rates, this 25 basis point increase was the smallest jump implemented by monetary policymakers since March of 2022. It seems that the recent slowdown in inflation may finally be leading to the Fed hitting the brakes on borrowing rate rises as well.

Fed Chairman Jerome Powell was cautious in his comments at yesterday’s press conference. While Powell stated to the public that the process by which the U.S. economy will return to more moderate consumer price increases has already begun, interest rates have yet to reach their peak. Powell implied that markets may expect two more interest rate hikes before the U.S. central bank backs off completely.

Despite Powell’s cautious stance regarding an end to rate hikes, major New York Indices reacted with optimism. By the ring of the closing bell on February 1st, the S&P 500 (USA 500) had gained 1% in value, the Nasdaq (US-TECH 100) had jumped by 2%, and the Dow Jones Industrial Average (USA 30) stayed mostly flat with a rise of .02%.

In recent months, Indices and Commodities the world over 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 the 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 stabilise rapid price increases across the American economy with a patently unstable global state of affairs.

 However, markets and policymakers alike may finally be seeing a light at the end of the tunnel. The consumer price increases that have put such stringent pressure on ordinary citizens’ pocketbooks the world over may finally be showing signs of retreat, and with this development, more moderate interest rate hikes could be on the horizon. While traders may be feeling optimistic at the moment, we would all be well-counselled to keep our eyes peeled for unexpected developments in the months ahead.