|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.
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.