Plus, how to tell when an interest rate cut is coming
The Federal Reserve has been in focus lately, amid pressure from President Donald Trump to lower interest rates and the nomination of former Fed Governor Kevin Warsh for next Fed Chair. As fears around central bank independence swirl, now is a good to review the role it plays in the economy.
What is the Fed?
The Federal Reserve is the U.S. central bank, and as such, dictates monetary policy via the discount rate, open market operations, and reserve requirements. The Federal Open Market Committee (FOMC) consists of a group of up to 12 central bank officials -- seven from the Board of Governors of the Federal Reserve System, the New York Fed President, and four of the 11 remaining regional Fed presidents (who serve one-year terms on a rotating basis).
The FOMC meets eight times per year to review and regulate the current monetary, economic, and financial situation. The committee's "dual mandate" calls for the group to make its policy decisions, with an eye toward both price stability and full employment.
Hawks, Doves, Hikes, and Cuts
While the post-financial crisis era led the FOMC to initiate large-scale asset purchases in an attempt to stabilize markets, most often the central bank committee is deciding whether they should raise the fed funds rate, reduce it, or leave it unchanged. Rate hikes are consistent with a strengthening economy, with those who advocate for such tightening described as "policy hawks." On the other end of the spectrum, rate cuts are generally done to ease lending during times of slower growth -- an approach favored by "doves."
While only the core group of Fed governors, four regional Fed presidents, and the New York Fed president are able to cast a vote on policy decisions, all members of the group convene to discuss economic indicators, the outlook for growth, and any foreseeable risks to their forecast.
How to Tell When a Rate Cut is Coming
The Fed's post-meeting statements typically offer fairly easy-to-decipher clues regarding likely future policy changes, with transparency and communication having improved quite a bit from Alan Greenspan's "Fedspeak" days.
In addition to parsing the Fed's post-meeting statements and meeting minutes, using the CME Group's FedWatch tool allows traders to gauge whether or not the market is pricing in a rate hike at a given meeting.