What is the FOMC?

Rick Welch: Dollars and $ense

What is the FOMC?

The FOMC or Federal Open Market Committee is responsible for the establishment and implementation of monetary policy of the Federal Reserve.  The Committee consists of twelve members – the seven members of the Federal Reserve Board of Governors, the President of the Federal Reserve Bank of New York and four of the remaining eleven Reserve Bank Presidents, who serve one-year terms on a rotating basis.  The FOMC holds eight regularly scheduled meetings, approximately every two months.  In 2016, the meetings are January 26-27, March 15-16, April 26-27, June 14-15, July 26-27, September 20-21, November 1-2 and December 13-14.   At these meetings, the Committee reviews current economic conditions, determines the appropriate posture of monetary policy and considers risks to achieving its dual mandate of encouraging maximum employment and controlling inflation with a long range target of 2.0%.

Monetary policy, as defined, “is the actions of a Central Bank (like the Federal Reserve) that determine the size and rate of growth of the money supply, which in turn affects interest rates.” Monetary policy, which influences both money and credit conditions in the economy, is maintained through actions such as modifying the interest rate charged to commercial banks (the target federal funds rate), buying or selling of government bonds, and changing reserve deposit requirements. The goal of these actions is to tighten or expand the money supply, depending on circumstances and the desired outcomes. 

The target federal funds rate, which is set by the FOMC, is the interest rate at which depository institutions (banks) lend reserve balances to other depository institutions overnight. Reserve balances are amounts held at the Federal Reserve to maintain depository reserve requirements.  At its December (2015) meeting the FOMC increased   the target fed funds rate from 0-0.25% to 0.25-0.50%.  This was the first change in the “fed rate” since 2008 when the FOMC lowered the rate at seven of its eight meetings, resulting in a decrease from 4.25% to 0-0.25%. One reason for the unprecedented move of having a range (0-0.25%) was that a rate of simply 0% could have problematic implications for money market funds. The theory behind the rate decreases in response to the great recession is that reducing the fed rate makes money cheaper and encourages banks to borrow more and subsequently extend more credit to borrowers.  While changes in the fed rate can impact the entire yield curve, typically we would expect short term consumer lending rates (auto loans and credit cards) to be impacted the most.  In contrast, mortgage rates are more reactive to changing expectations in the outlook for economic growth and inflation.  

The path to interest rate normalization will be a challenging one for the FOMC as it must proceed carefully so as not to adversely affect economic growth. The financial markets will watch closely and react to the perceived path of the fed funds rate over time.   Since the initial rate hike in December, Fed Chair Yellen has emphasized that Fed monetary policy will remain accommodative in the early stages of the normalization process and that the longer term pace of rate increases will be gradual.  The pace of rate increases may depend on realized and expected economic conditions both here and abroad. It is clear that monetary policy signals can and will be communicated both in action and word.  Communication by the FOMC, both timely and transparent, will be an important ingredient for success along the way. Clarity of purpose and intention will be critical to reducing investor uncertainty and the accompanying market volatility.

 

                                                                                                                  Richard M. Welch, Jr.                                                 
                                                                                                                  Shareholder and Chief Investment Officer
 (P) 215 603 2976                                                          

                                                                              rickwelch@academywealthadvisers.com   

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