The Federal Reserve has become an increasingly powerful force in the stock market, as our Senior V.P. of Research Todd Salamone has documented in his weekly Monday Morning Outlook column. With another Fed policy decision approaching in December, along with a changing of the guard at the central bank, now is a good time to review some Fed basics.
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 meetseight 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.
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.
Looking toward the December Fed meeting, a hike in interest rates is widely expected, based on recent meeting minutes and public comments from Fed officials. 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. As of this writing, fed fund futures are pricing in a greater than 91% chance of a rate hike in December.
As Todd has reported, the market has been rallying after meetings when the FOMC leaves rates alone, with choppy-to-lower trading ensuing after most rate hikes in the current tightening cycle. In his latest assessment, he warned, "...if the Fed indeed raises rates in mid-December, as expected, it could result in equity market weakness into January as some of the optimism we are seeing now begins to unwind."
In addition to policy changes, the Fed has also been grabbing headlines lately for some high-profile personnel shake-ups. Vice Chair Stanley Fischer resigned in October, citing personal reasons, and New York Fed President William Dudley is targeting mid-2018 for his retirement.
The biggest change, though, is the upcoming departure of Fed Chair Janet Yellen, who took the top job from Ben Bernanke in early 2014. Shortly after President Donald Trump recently tapped Fed Governor Jerome Powell to take over the role of FOMC chair in February, Yellen announced she would resign from the Board of Governors once her successor takes over. Her term on the board wasn't set to expire until 2024.
Meanwhile, Powell will have to receive approval from the Senate before he is sworn in next February. After a grilling from the Banking Committee, he'll need to garner a 51-vote majority approval in the Senate.