FOMC: What Is It and What Does It Do? How Does It Affect The World Economy?

Whenever there's a FOMC meeting, every investor will monitor the screen closely and check the FOMC's monetary decision. Why is that so? And what makes FOMC meetings so powerful that investors pay close attention to them? Take it easy because we've got you a newbie guide to tell you everything you need to know about FOMC. Let's go!

What Is FOMC?

The Federal Open Market Committee (FOMC) is the core monetary policy-making body of the central bank of the U.S.—the U.S. Federal Reserve. It's responsible for setting the interest rate and deciding monetary policy direction to stabilize prices and maximize employment levels.

FOMC Meetings

During the private FOMC meeting, the Board of Governors and all 12 Reserve Bank presidents will discuss the decisions of interest rates, monetary policy and their rationales with economic performance like GPD growth, inflation and unemployment rate and other economic data.

There will be eight FOMC meetings a year and even more if needed.

What Does FOMC Do?

The FOMC is like the captain of a ship, steering the economy in the right direction to facilitate stable economic growth.

When the economy needs a boost, the Fed shifts into expansionary policy, also known as loosening policy, by increasing the money supply and lowering interest rates.

However, if the economy starts to overheat and inflation starts to rise, the Fed shifts into contractionary policy, also known as tightening policy, to put a brake on the overheating economy by decreasing the money supply and raising interest rates.

Here are the four standard tools the FOMC uses to make changes to monetary policy.

The Discount Rate

Most people have the misconception that the Fed sets the interest rate for banks directly, but that's not true.

The Committee adjusts interest rates by setting a target range for the market Fed funds rate, which is the rate that banks charge each other for overnight loans. Then, the Fed adjusts the Fed fund rates by adjusting the money supply with the discount rate.

The discount rate is like the secret cash resort commercial banks can borrow from the Federal Reserve. Think of it as an emergency loan that banks can tap into if they need extra cash in a pinch.

By adjusting the discount rate, the Federal Reserve can control how expensive it is for banks to borrow and, as a result, influence how much credit is available in the economy.

So, it's like the Federal Reserve has a lever to tweak the flow of money in the economy!

Open Market Operations

Open market operations are one of the essential tools used by the FOMC to regulate the money supply. Simply put, it's the buying and selling of Treasury securities by the Federal Reserve in the open market.

By buying more Treasury securities, the Federal Reserve expands the money supply and puts downward pressure on interest rates. Conversely, by selling Treasury securities, the Federal Reserve contracts the money supply and puts upward pressure on interest rates.

The Reserve Requirement

The reserve requirement is the minimum amount banks must keep in reserve. The Federal Reserve can lower the reserve requirement to make more money available for lending and lower market interest rates. Conversely, by raising the reserve requirement, the Federal Reserve can reduce the money supply and increase interest rates.

Interest on Excess Reserves

Interest on Excess Reserves (IOER) is the interest paid by the Federal Reserve to commercial banks on the funds they hold in reserve at the Fed.

High IOER encourages banks to keep a portion of their excess funds at the Fed rather than lending them out in the market, which could decrease the money supply and potentially lead to inflation.

If the Federal Reserve wants to increase the money supply and lower interest rates, it can lower the IOER rate. This would encourage banks to lend out their excess funds, expanding the money supply and putting downward pressure on interest rates.

How Does FOMC Affect the Market and World Economy?

The FOMC's interest rate decisions significantly impact the world economy because they affect the financing costs of running a business and general public spending.

However, the Fed needs to be extremely careful with interest rate setting because if it's too low, the economy will be overheated, causing inflation and an overheated economy. On the other hand, if the interest rate is set too high, the economy may be discouraged and turn into a recession with drastically rising business borrowing costs and reduced spending.

FOMC and Bonds

Interest rates and bonds have an inverse relationship, meaning that when interest rates rise, bond prices fall, and vice versa.

Bonds are debt securities that pay a fixed interest rate over a specified time. So, when interest rates go up, new bonds being issued will pay a higher interest rate to reflect the new rate. And this makes the existing bonds with lower interest rates less attractive. In the end, the price of existing bonds decreases to compensate for the lower yield.

FOMC and Forex

By adjusting interest rates, the FOMC can influence the exchange value of the U.S. dollar. When they raise interest rates, the demand for the U.S. dollar from bond purchases may increase, causing its value to rise.

FOMC and S&P 500

If the FOMC bumps up interest rates, the economy might slow down, and stock prices could drop because higher interest rates make it more expensive for businesses to get loans and can lower how much people spend.

FOMC and cryptocurrency

The FOMC's monetary decision has an indirect impact on cryptocurrency. When the FOMC raises interest rates, it may reduce demand for risky assets, such as cryptocurrencies, as investors shift their investments to less risky financial products that offer a higher return.

Why Are FOMC Minutes Important?

FOMO minutes are the follow-up note that records the detailed decision-making process, such as what factors the Fed members have considered and their attitude towards each aspect. That gives us valuable long-term insight to make a rational prediction of the Fed's next move.

The Factors Influencing the FOMC's Decisions

GDP, inflation, employment rate, and economic prospects are the three core factors that the Fed generally considers when they make decisions.

GDP is the economic growth index that shows the gross domestic product's value. If GDP decreases, the Fed might consider loosening monetary policy to stimulate greater growth.

Inflation is one of the core factors to consider. If the inflation is too high, the Fed has the need to curb the overheating economy, so you may expect the Fed will increase the interest rate.

The unemployment rate is another factor for the Fed to consider. Suppose there's an increasing trend in the unemployment rate. In that case, the Fed has a great possibility of decreasing the interest rate to stimulate economic growth.

Economic prospects are the last factor we could pay attention to. Different Fed members have different economic prospects. It would be an advantage if you understood the general overview of the Fed's economic perspective and could predict their next moves.

Fed Members' Dovish and Hawkish Tendencies

The minutes offer a rare look into the inner workings of the committee, providing vital information about its level of unity or division. Did any of the FOMC members have dissenting opinions? Did they disagree on the best course of action?

FOMC minutes are traces of the thinking process behind the decisions. If you could crack the code of the Fed member’s mindset, you will gain some insight of what they will move next (and you could make your move before them.)

What Is the Current FOMC Rate?

Earlier this month, in February 2023, the FOMC raised the interest rate by 25 basis points, taking it to a new range of 4.50% to 4.75%, up from near zero a year ago. Compared to the four preceding meetings, the 25 basis point increase this month implies a slower pace of the Fed's tightening monetary policy.

What Are the Dates of the FOMC Meeting in 2023?

During the period of the FOMC meeting, the market is expected to be volatile. Don't forget to mark down the dates of the FOMC meetings in 2023:

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