What Is The Federal Open Market Committee (FOMC)
The FOMC is the policy-making arm of the U.S. Federal Reserve. The FOMC determines short-term interest rates in the U.S. by manipulating the overnight interest rate that banks pay each other for borrowing reserves. Banks borrow reserves when a bank has a shortfall in required reserves. This overnight rate is the fed funds rate.
The Federal Open Market Committee also determines whether the Fed should manipulate liquidity in credit markets by other means. The Fed announces its policy decision (whether to change the fed funds target rate or not) at the end of each FOMC meeting. This is the FOMC announcement. It also includes brief comments on the FOMC’s views on the economy and how many FOMC members voted for and against the policy decision.
Since the last recession, the statement also includes information on Fed purchases of assets, aka “quantitative easing”, which affects long-term interest rates.
Why Is The FOMC announcement important?
The Fed determines interest rate policy at FOMC meetings. A FOMC meeting happens approximately every six weeks. The FOMC meetings are the single most influential event in the markets. For weeks in advance, market participants speculate about the outcome of each meeting. If the outcome is different from expectations, the impact on the markets can be significant.
Why Is The Federal Funds Rate Important?
The interest rate set by the Fed, the federal funds rate, serves as a benchmark for all other rates….All. Other. Rates.
A change in the fed funds rate (the lending rate banks charge each other for the use of overnight funds) affects all other interest rates from Treasury bonds to mortgage loans. It also changes the flow of investment dollars. When bonds yield 5 percent, they will take more investment away from equities than when they only yield 3 percent.
Interest rates impact the economy in various ways. Higher interest rates tend to slow economic activity; lower interest rates tend to stimulate economic activity while at the same time erode pension fund returns and consumer savings. Either way, interest rates influence consumer sales. In the consumer sector, fewer homes or cars will be purchased when interest rates rise.
Furthermore, interest expense is a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. When interest expenses increase, net profit decreases which lowers corporate profit. The bottom line is that higher interest rates are bearish for equities. While a low interest rate environment is bullish for equities AND juices up government tax revenue. Get the picture?