Interest Rates and the Current Fed

Interest rates have had an interesting ride this month. What’s causing some of the movement in rates? The short answer is that the Federal Reserve (Fed) and the Federal Open Market Committee (FOMC) have a lot to do with it.

The Federal Reserve Act of 1913 created the Federal Reserve System as the central bank of the United States.¹The Federal Reserve performs five general functions to promote the effective operation of the US Economy: it conducts monetary policy, promotes the stability of the financial system, promotes the safety and soundness of individual financial institutions, fosters payment and settlement system safety and efficiency, and promotes consumer protection and community development.²Regarding conducting monetary policy, since 1977, the Fed has operated under a dual mandate from Congress to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates”.³ The monetary policy tools that the Fed uses to achieve its objectives are mechanisms to tighten the money supply or loosen the money supply, depending on the current economic data and outlook.

The Federal Reserve Controls the three tools of monetary policy which are open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations.⁴ Last week the FOMC had one of its eight yearly meetings to review economic conditions and to decide on whether to add stimulus or to withdraw stimulus from the money supply. Although the FOMC decided to maintain the target range for federal funds at 2.25 to 2.50, the Fed seemed to take a much more dovish stance regarding future actions. The Fed funds futures market, leading into the meeting, had priced in a high probability of potentially three rate cuts for the year, but was looking for some validation from the Fed. Given the potential threats to global growth in general, and the US economy specifically, the Fed struck a somewhat more cautious tone in their statement when describing current conditions. Specifically, they stated “The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes, but uncertainties about this outlook have increased. In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.”

Another wrinkle to the Fed’s current monetary policy position, is the overt pressure from the Executive branch of the government, to cut rates. Although the Fed is independent, and does not take into account political influences, one must wonder if that has weighed on their current position. That being said, the Fed may be trying to get ahead of a downturn by preemptively being accommodative before any trouble starts. Only time will tell if the Fed’s policies are the right medicine, however FOMC meetings and Fed moves for the rest of the calendar year, should be interesting.

¹The Board of Governors of the Federal Reserve System (https://www.federalreserve.gov/aboutthefed/fract.htm)

²Overview of the Federal Reserve System (https://www.federalreserve.gov/aboutthefed/files/pf_1.pdf)

³The Federal Reserve’s “Dual Mandate”: The Evolution of an Idea

Aaron Steelman

⁴About the FOMC (https://www.federalreserve.gov/monetarypolicy/fomc.htm)