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 is set to conclude its second meeting of the year today, March 16th, followed by a press conference. An atmosphere of volatility has been prevalent on Wall Street this week, with investors unsure how soon an interest rate hike will be instituted by the Fed. Following today’s meeting, the U.S. central bank’s proximate intentions regarding the battle against inflation could become clearer. 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 for 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 and the economy growing at a sustainable rate. The twelve members then vote on whether buying or selling securities is more likely to attain these goals. The meeting, which began yesterday and will conclude today, March 16th, with a press conference, is the committee’s second summit 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 Governor’s 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) could be watching the FOMC meeting’s outcome with great interest this week.
How Might the Stock Market Respond?
While major American Indices are currently facing significant headwinds, according to many analysts, there may be light on the horizon. Major New York markets seem to have been able to surf the successive waves of coronavirus infections, but other issues are now beginning to appear.
Despite the travails of the ongoing COVID-19 pandemic, the S&P 500 is still significantly higher than it was in March 2020, prior to the widespread lockdowns. However, this premier index has opened 2022 with its worst start since the early months of the pandemic. With stock markets facing record-high inflation, as well as the fallout of Russia’s military engagement in Ukraine, the potential effects of a shift in monetary policy on the Nasdaq (US-TECH 100) and Dow Jones Industrial Index (USA 30) could be at the forefront of FOMC members’ minds as they conclude their deliberations today.
Historically, volatility has ruled the trading floors of Wall Street in the period immediately following an interest rate hike. However, after each of the four cycles of interest rate rises implemented by the Federal Reserve since the first Reagan administration, the S&P 500 (USA 500) had risen by the time a year had passed since the first rate hike of the cycle.
Despite these encouraging precedents, American markets are currently grappling with an issue that hasn’t reared its head during an interest rate rise cycle since the early 1980’s: high Oil (CL) prices. Although petroleum’s cost per barrel is down from its near 14-year peak of ten days ago, the as-yet-unclear effects of expanding embargoes on energy exports from the Russian Federation have some analysts speaking of a potential ‘Oil Shock’ to markets akin to that experienced following the Yom Kippur War of 1973. Despite these challenges, most observers agree that the Federal Open Market Committee will most likely announce an interest rate hike later today.
What Is Expected From This Week’s Meeting?
Currently, the committee’s chair is Jerome Powell, widely-regarded as a moderate when it comes to stimulus decisions. Powell was appointed to his position in 2018, and his first four-year term will end in February; however, President Biden nominated him for a second four-year term in November. If confirmed by the Senate, he will continue in his position until 2026.
Powell is expected to announce today that the U.S. central bank will raise interest rates by a quarter point in response to continually rising inflation, despite the uncertain market mood in many sectors. Although Powell championed a policy of ‘easy money’, or low interest rates, and high liquidity for the first two years of the coronavirus pandemic in order to avoid economic disaster, the Federal Reserve chairman has repeatedly signalled in recent months that the time for monetary tightening was drawing closer. That point seems likely to be officially reached today.
The appetite for hawkishness that may be prevalent in the Fed’s boardrooms today might have received even greater impetus from recent events. Significant disturbance to global supply chains due to Russia’s rapid economic isolation as well as the coronavirus lockdown implemented in the southern Chinese manufacturing hub of Shenzhen have the potential to stun economic growth and turbo boost inflation.
Along with the expected indication of a quarter point interest rate hike, market watchers may also receive information regarding the trajectory of future rate rises today as well. Some have even raised the possibility of up to half-a-dozen increases by the end of 2022.
In recent weeks, 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 affairs. Following the remarks to be delivered later today, we may get a much better handle on where U.S. monetary policy is headed this year.