Have you ever wondered why stock traders on Wall Street always pay close attention to the U.S. Federal Reserve’s meetings and activities?
Well, the Federal Reserve, commonly referred to as the Fed, is the most important central bank in the world because of the U.S. dollar’s special role as the main reserve currency for the global economy.
The Fed’s Federal Open Market Committee (FOMC) meeting is one of the most important events in the economic calendar.
In this post, we’ll explain what FOMC meetings are and why they should matter to you as a day trader. But before we go into greater detail about these meetings, let’s talk a little about the Fed in general.
What is the Fed and what does it do?
The Federal Reserve was established through an act of Congress in December 1913 to help oversee the financial industry.
Although the central bank traces its roots to the first U.S. Treasury Secretary Alexander Hamilton, its current set-up is based on the Federal Reserve Act that was signed into law by President Woodrow Wilson in 1913.
Before its creation, many U.S. banks were going out of business, thus putting the savings and lives of millions of Americans at risk.
Today, the Fed is a huge institution with power over economies and people all over the world. Its decisions shape job growth and interest rates. They affect the stock market, financial systems, bank rules, and international trade.
Retirement savings ride on Fed policies. Economic decisions are also made with the central bank in mind.
The Fed comprises of three major branches Board of Governors, 12 Federal Reserve banks, and the FOMC.
What is the FOMC meeting?
The Federal Open Market Committee is a special committee of the Federal Reserve that is led by the Fed President, a position currently held by Jerome H. Powell.
This is arguably the most influential branch of the Fed. It became an arm of the central bank in the 1930s and its task is to analyze the economy and make necessary monetary policy decisions.
The FOMC makes these policy decisions in its planned – and sometimes emergency – meetings. This body consists of the Board of Governors, the President of the Federal Reserve Bank of New York; and 4 of the remaining eleven Reserve Bank presidents, who serve rotating, one-year terms.
FOMC members typically meet eight times per year, but there is scope for more meetings if necessary. During these meetings, the policymakers review the nation’s economic growth and manage interest rates.
When you see news outlets report “the Fed has left interest rates unchanged today,” they are referring to a move by the FOMC.
Functions of the FOMC
As we mentioned before, the role of the FOMC is to monitor the U.S. economy and adjust federal fund rates as it sees fit.
In the wake of the financial crisis of 2007-08, the committee has also been mandated with more tasks including quantitative easing (QE), a monetary policy strategy in which it buys long-term bonds to encourage borrowing and spur economic growth.
The FOMC utilizes a set of tools at its disposal to keep prices stable and attain maximum employment. To achieve, the FOMC must keep inflation and unemployment in check.
For example, throughout the coronavirus pandemic, it has repeatedly said that it would start scaling back, or “tapering,” its stimulus bond-buying program.
When and where does the FOMC hold its meetings?
By law, FOMC members have to meet at least four times per year, translating to about once every six weeks. However, in recent years, the FOMC has held more than eight times in a year.
Its most recent meeting happened on December 14 and 15. In 2022, the first three FOMC meetings will be held on:
- January 25-26
- March 15-16
- May 3-4
The meetings are held in Washington, D.C., and are attended by the Fed’s Board of Governors, the presidents of the 12 Federal Reserve Banks, and some senior Federal Reserve staff members.
Why FOMC meetings are so important
The FOMC meeting is without a doubt one of the most closely watched events on the economic calendar.
At the conclusion, FOMC members usually set the federal funds rates, a target range for the rate that banks charge each other for overnight lending.
Adjustments to the federal fund rates typically affect the long-term rates that banks charge borrowers, and set borrowing costs for business loans, mortgages, and credit cards. However, it is worth noting that the Fed has no direct control over those rates.
The Fed works to prevent inflation from hurting the economy, which can happen if the economy grows at a faster pace. It is also tasked with ensuring the economy does not slow down too much to avoid stalling into a recession.
Normally, when the Fed wants to encourage lending by reducing the cost of borrowing for consumers and companies, it trims its target short-term interest rate.
The FOMC deploys this strategy when the economy is in a challenging period such as the Covid pandemic or the financial crisis. Its goal is to promote consumption by incentivizing people to move money from savings.
On the other hand, if inflation appears to be growing or the economy is expanding too fast, the Fed will hike interest rates. Higher interest rates tend to slow consumer spending and business growth.
For instance, during the most recent FOMC meeting, the central bank announced plans to taper its bond-buying program faster than originally planned. Policymakers also paved the way for possible interest rate hikes in 2022.
The $120 billion program was initiated last year in the early days of the pandemic as a way to prevent any market disruptions and keep low borrowing costs across the economy.
Scrapping the program earlier would give the central bank more flexibility to hike federal fund rates from their current ultra-low level of 0-0.25%, if necessary, to keep inflation from getting out of control.
FOMC Minutes
Upon completing its meetings, the FOMC typically releases the official details from the meetings about two weeks later. Traders often see the minutes as a potential market catalyst, particularly if the committee changes direction or hints at future actions regarding monetary policy.
Stock traders and other market participants price in expected Fed action before the minutes are released. Studies show that the minutes can have a huge effect on Treasury bond yields as well.
The effects are largest when minutes have a different tone from the statement. This presumably leads markets to change their expectations of future monetary policy.
Bottom Line
The job of the Fed is to ensure that the U.S. economy is operating effectively. It has a lot of power to sway the economy, and this somehow determines how the stock market behaves.
While stocks are not the economy, their performance can be seen as a reflection of how confident consumers are about the current and future state of the economy.
Top economists and financial media outlets love to talk about the Fed’s monetary-policy announcements and what their implications are for the markets.
They routinely forecast the outcomes of FOMC meetings and statements, which reveal the central bank’s new target federal fund rates, and normally react when the Fed fails to act as expected.
An FOMC announcement is a contractionary surprise when the new target rate is higher than the market expectations and expansionary when it’s lower than forecasts.
As a day trader, you should always keep an eye on FOMC meetings and minutes, and pay close attention to the direction of interest rates.