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.
On Wednesday, December 13, 2023, in its eighth and last monetary policy meeting of the year, the Federal Open Market Committee (FOMC) announced its decision to uphold the benchmark interest rates within the 5.25% to 5.5% range for the third consecutive time, marking the highest rates in 22 years.
Despite keeping rates at an all-time high and in spite of its persistent hawkishness, the Central Bank indicated that rate cuts may be on the horizon in 2024.
With less than a month away from the new year, traders, investors, and consumers may be waiting eagerly to see which route the world’s biggest economy’s Central Bank will take in the new year.
Here’s what you need to know about the FOMC’s last meeting of 2023 and how the markets reacted to their decision in response:
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. (Source: The Federal Reserve)
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.
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.
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 committee's eighth and last meeting of 2023 began Tuesday, December 12, and concluded Wednesday, December 13 followed by a press conference and a speech by Fed Chairman Jerome Powell.
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.
In addition, it may be worth noting that the Fed’s decision can have a notable impact on stocks, in general, and on tech stocks in particular. This is because tech stocks, which are usually considered growth stocks, tend to be susceptible to higher rates since they are “long-duration” assets.
In addition, during times of inflation and high interest rates, many investors and traders shy away from tech stocks as they opt for safe-haven assets instead.
What Do the Fed’s Projections for 2024 Indicate?
While the Fed has made multiple headlines this year for its hawkish interest rate hikes, many Fed members project a shift of direction for the new year.
As per the Federal Reserve's projections for 2024, the Fed will likely cut rates by about 75 basis points (0.75%) in the new year. To be more precise, according to the Fed, these cuts will likely take place thrice in 2024.
The shift in tone is attributed to optimistic expectations of inflation decreasing to 2.4% in the upcoming year and further to 2.2% in 2025.
Fed Chairman, Jerome Powell, explained that the Fed acknowledges that its “likely at or near the peak rate for this cycle,” while still indicating that the potential for further rate hikes isn’t “off the table.”
Powell went on to say that “Nobody is declaring victory,” yet. As such, it is important to note that what 2024 will indeed usher forth is yet to be determined and multiple factors can come into play and affect the Fed’s monetary policy. (Source: Yahoo Finance)
The Fed’s New Dot Plot
Following the FOMC meeting, the Federal Reserve released a Dot Plot; a graphical representation utilizing data points plotted as dots on a chart (released quarterly). This chart shows the Fed members' projections for the future of the Federal Fund Rates, and each Fed member’s projection is represented by an anonymous dot.
Given its importance and the fact that the Dot Plot is closely monitored by investors and analysts, traders may be interested to know that the latest Dot Plot showed that many Fed officials believe that the Fed funds rate will peak at 4.6% in 2024. This is a decrease from the previous September projection of 5.1%.
The Dot Plot showed that the majority of Fed officials predict cuts in 2024 with only two officials seeing borrowing costs holding steady that year. However, only time will tell whether these projections will come to fruition.
How Are the Markets Reacting?
Following the release of the FOMC’s decision on Tuesday, Wall Street indices rallied as the S&P 500 (USA 500), the Nasdaq (US-TECH 100), and the Dow Jones Industrial Average (USA 30- Wall Steet) soared by 1.37%, 1.38%, and 1.40% respectively.
To conclude, despite 2023’s ongoing hawkishness, the Federal Reserve's 2024 projections suggest a shift towards interest rate cuts driven by optimism about decreasing inflation.
Nonetheless, Fed Chairman Powell doesn't rule out future hikes in the future, and traders may want to be prudent with their projections and keep an eye out for potential monetary policy shifts.