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.
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, and 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 to be held from December 14-15 will be the FOMC’s eighth and final meeting of 2021.
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 Citigroup (C) could be watching the FOMC meeting’s outcome with great interest this week.
How Might the Stock Market Respond?
With both the S&P 500 (ES) and the Dow Jones Industrial Index (YM) showing general uptrends since fears sparked by the coronavirus’ Omicron variant somewhat subsided, the Fed may feel less compelled to prolong the bond-buying economic support program.
As of Monday morning, the S&P 500 was trading up by almost 0.2%, after last week marked the index’s best trading week since February of this year. The Dow was trading nearly flat as of the time of this writing, after an almost 0.7% jump last Friday.
However, the FOMC’s decision this week could put the brakes on such quick growth on the stock market. An interest rate rise caused by a cutback in stimulus from the Fed would increase borrowing costs, and could return the stock market to a state of volatility like that seen in 2020.
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.
In late November 2021, Powell indicated to the Senate that cutting the Fed’s bond-buying more quickly than planned would be on the table at the FOMC meeting on December 14th and 15th. The Federal Reserve is currently planning to purchase $15 billion less of bonds each month, so that by next June the bond-buying program will be ended completely.
However, many market analysts see a high likelihood of the FOMC moving to taper purchases down even more quickly, given the predominantly hawkish makeup of the committee going into tomorrow’s meeting. Even San Francisco Federal Reserve Bank President Mary Daly, generally seen as a dove, stated on November 24th that such a move would be considered at the FOMC meeting.
As inflation in the United States recently hit the dubious milestone of its highest level in nearly four decades, many market watchers believe that the Fed could move to increase the federal funds rate. This would lead to a general interest rate increase across the economy, and possibly evade the danger of the economy ‘overheating’.
The Federal Reserve has already stopped referring to the country’s rising inflation as transitory, and may even be the first central bank to raise interest rates following the pandemic. With a seemingly strong stock market, it remains to be seen whether Wednesday’s press conference will reveal that the Federal Open Market Committee has decided to change course.