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Main » Articles » Forex for Beginners

The Federal Reserve and The FOMC Committee
by Tim Salem

FXstreet.com Independent Analyst Team

The Federal Reserve is the Central Bank of the United States, setting Monetary Policy and broadly ensuring the stability and development of the US Financial System.

Comprised of the Board of Governors in Washington DC and 12 regional banks, the Federal Reserve's Mandate is the following:

  • The Setting of Monetary Policy to ensure Economic Growth and Currency Stability.
  • To Regulate United States Banking Institutions.
  • To Maintain the Macro-Stability of the U.S. Financial System.
  • To Provide Financial Services to the U.S. Government.

Monetary Policy

The Primary responsibility of The Federal Reserve is to set Monetary Policy to ensure a Stable Currency and Healthy Economic Growth. The Federal Open Market Committee (FOMC) sets Reserve Requirements (the % of Deposits in which Banking Institutions are required to hold on Reserve), the Discount Rate “Window” (meaning the Prime Interest Rate, or the cost of Short-Term Lending), and Open Market Agendas (where The Fed may influence and move The Markets through Intervention by Verbal (known as “Jawboning”) and Actual Means with setting New Policy and Terms as needed.

The FOMC (Federal Open Market Committee)

The Committee consists of a 12-Member Unit that sets Credit and Interest Rate Policy for the entire Federal Reserve System. The Participants consist of 7 Members of The Board of Governors, and 5 Members of the 12 Federal Reserve Regional Bank Presidents. The Chairman of The Federal Reserve Board heads the Group, and the Primary Purpose of The FOMC is to Set Interest rate Policy Directly by changing the Discount rate, or by using Open Market Operational Policy, which consists largely of Purchasing and Selling Government Securities which have a Direct Effect on the Federal Funds Rate.

The FOMC Rate Decision

The Committee convenes eight times per year to decide Monetary Policy concerning if Interest Rates are to be Maintained, Increased, or Decreased in nature. The Decision is made public after each Meeting, as The FOMC keeps Inflationary Concerns within a certain Target Level by “fixing” the Overnight Borrowing Rate, which sets Short-Term Lending Rates throughout the U.S. The ultimate Goal of these Measures is to insure stable Economic Growth and Employment.

The Trader’s perspective is most likely concerned with the Cash Rate Target Decisions, as these will have significant Effect on the Financial Markets as a whole. The Overnight “Call” Rates effect Mortgages, Bonds, Consumer Loans, and most importantly for Traders, the Exchange Rate of the U.S. Dollar. The Exchange Rate of the Dollar will usually Appreciate if Interest Rates are Increased, or if there is an Expectation of Rates going higher. A Decrease, or an Expectation of an Interest rate Decrease will cause the Dollar to Depreciate. A unique Aspect about Federal Reserve Policy is not to emphasize an “Official” Target Inflations Rate as other Central banks do, but to use a more flexible and independent Perspective in implementing and monitoring overall Monetary Policy.

A Statement is issued by the FOMC after every Rate Announcement around 18:00 GMT. The Rhetoric of the Statement is highly selective and sometimes obtuse in nature, as it is often more Crucial to Market Sentiment and Activity than the Decision Itself. This is due to the Statement containing specific Language usually concerning the “Outlook” of the Federal Reserve’s Monetary Policy and Mission moving forward. The Key is that the “Sentiment” concerning Interest Rate Direction is more important and anticipated than the actual Current Rate Itself.

Trading Thoughts and Ideas for the FOMC Rate Decisions and Statements

In the Immediate and Primary-Term, Traders will focus on the Initial Interest rate Decision Itself.

If there is an Increase in Interest Rate, the U.S. Dollar will usually Appreciate on the Decision. This is due to a Hike in Rates increasing the Interest Rate Yield offered by U.S. Asset Classes. This attracts Foreign Investment Entities into the U.S. Dollar which is attractive and healthy for the Economy. The “Degree” of Positive Reaction for The Dollar will be dependent on how much the Market has already expected and “Priced-In” the Decision, along with any Rhetoric from the Statement indicative of more Rate Hikes to come.

If there is a Decrease in Interest Rate, the U.S. Dollar will usually Depreciate on the Decision. This is due to a Cut in Rates decreasing the Interest Rate Yield offered by U.S. Asset Classes. This decreases and stalls Foreign Investment Entities into the U.S. Dollar which is perceived to be unattractive from an Investment Perspective. This is due to the perception of a weakening Economy that mandates a Reduction in Monetary Tightening, or an increase in Market Stimulus (Quantitative Easing) to stimulate further Growth. The “Degree” of Negative Reaction for The Dollar will be dependent on how much the Market has already expected and “Priced-In” the Decision, along with any Rhetoric from the Statement indicative of more Rate Cuts to come.

If there is No Change in the Interest Rate, these are the Crucial Moments when the Statement and Rhetoric come into View, as Dollar reaction will depending on the future Outlook and Sentiment, as well as the Policy Measures the Fed Cycle is emerging from (a Pausing, Tightening or Easing Cycle).

The following Statements may be made concerning a Rate Holding Scenario:

  • If the Cycle was one of Tightening Rates, this would be Bearish Sentiment for The Dollar.
  • If the Cycle was one of Easing Rates, this would be Bullish Sentiment for The Dollar.
  • If the Cycle was one of Pausing Rates, the Sentiment would be rather Neutral for The Dollar.

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Category: Forex for Beginners | Added by: forex-market (2009-06-24)
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