FOMC - what is it and what does it do

What is FOMC?

In the world of economics, there are two big components that traders need to be aware of: monetary and fiscal policy. The first one involves managing the money supply and interest rates, while the second refers to how governments invest money.

The Federal Open Market Committee or FOMC is part of the U.S Federal Reserve in charge of controlling the money supply and monetary policy. During Fed meetings, the board can announce interest rate decisions, which can result in either buying or selling U.S government securities and thus helping the economy grow.

 

What is the structure of the FOMC?

There are twelve members with voting rights inside the FOMC: Chairman Jerome Powell, Vice Chairman John C. Williams and the members of the Board of Governors (Richard H. Clarida, Randal K. Quarles, Michelle W. Bowman, and Lael Brainard), alongside four other bank presidents (Patrick Harker - Philadelphia; Robert S. Kaplan - Dallas; Neel Kashkari - Minneapolis and Loretta J. Mester - Cleveland). Alternate members who serve on a rotating basis with one-year terms: Thomas I. Barkin - Richmond,  Raphael W. Bostic - Atlanta, Mary C. Daly - San Francisco, Charles L. Evans - Chicago, and Michael Strine - First Vice President, New York.

The rotating seats are chosen from four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco. Additionally, nonvoting Reserve Bank presidents also attend the meetings of the Committee, participate in the discussions, and contribute to the Committee's assessment of the economy and policy options.

Role of FOMC - Scheduled meetings

The Federal Open Market Committee (FOMC) normally has eight scheduled meetings per year. They also might hold additional meetings should the situation require. Because talks are secret, there is usually plenty of speculation on Wall Street regarding monetary policy decisions and fund rates.

During these meetings, the committee analyzes past and current economic developments to make well-informed decisions. A lot of important factors are taken into account here, including trends in prices and wages, consumers’ income and spending habits, interest rates, GDP growth, lending trends, and fiscal policy.

Essential decisions are stated during a press conference shortly afterward when the federal funds rate is also announced. The FOMC minutes are released after the meeting.

Federal funds rate

The federal funds rate refers to the interest rate that banks charge each other for overnight loans. In short, it reflects the base interest rate for the US economy. Any changes to the federal funds rate affect short and long-term interest rates, forex rates, and economic factors such as unemployment or inflation.

Key term - quantitative easing programs (QE)

The QE happens when other policy measures have failed to provide results, and the Federal funds rate is very low. In such a scenario, U.S Central Bank buys government securities or other securities from the market to increase the money supply and support lending and investment.

These measures stimulate the economy, banks can loan more and replace the sold assets with newer ones, thus re-establishing the normal economic flow.

FOMC impact on the financial markets

The FOMC meeting is one of the most important events in any trader’s agenda for one very important reason: interest rates. Whenever the FOMC lowers or raises interest rates, the global financial markets feel the effects. Here’s why and how:

Currency pairs linked to the USD

Higher interest rates provide support for the world’s most traded currency - the US dollar - while lower interest rates have the opposite effect. The major dollar currency pairs tend to move as a consequence, including EUR/USD, GBP/USD or USD/JPY.

Indices & Bonds

Increasing interest rates affect consumer and business spending. US indices such as Dow Jones, S&P 500, or VIX are the first to feel the heat. Bonds such as the 10 Year Note also tend to react to interest rate decisions, falling when rates go up and increasing when rates go down.

Commodities

The greenback has an impact on commodities such as precious metals and oil. A weaker dollar leads to higher gold, silver, and crude oil prices. As a side note, gold is a favorite safe-haven asset for traders, who usually opt to invest in it when the dollar tumbles out, and the economy falls.

Sources: investopedia.com, federalreserve.gov

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