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Monday, September 20, 2010

What is the FOMC?

DIY investors need to keep an eye on the Fed and, in particular, the committee that sets monetary policy - the FOMC. FOMC stands for "Federal Open Market Committee." By going to the Econoday calendar at the Bloomberg site, you see that, on Tuesday of this week at 2:15 pm (this is approximate), the FOMC will release a statement. The statement gives a short blurb on policy actions, if any, and short commentary on economic conditions the committee considered. It also will hint at which direction they are leaning - towards increasing or decreasing short-term interest rates.

If you are interested in the 3-ring circus surrounding this event, tune into CNBC at 2:10 pm, or so, to see the usual talking heads - bond gurus, ex. Fed governors, and economists - parse the Fed statement and make a huge deal out of any slight change in the Fed's wording.

The specific rate they target is the federal funds rate. This is the rate banks charge each other to borrow and lend reserves. Banks with excess reserves can lend at this rate to banks deficient in reserves. The rate is important because rates are linked. A bank with excess reserves can do a lot of things with excess reserves: it can make a loan (at least they considered this in the past!); it can buy Treasury bills; it can hold the reserves at the Fed.

Longer-term rates are less influenced by the Fed's actions in the short-term market and are more influenced by inflation expectations. Thus, though the Fed's manipulating of the federal funds target will have some influence on 30 year fixed rate mortgages, the bigger influence will be the rise or fall of expected inflation - at least this is the way it used to be.

Today the Fed has pretty much run out of room on the federal funds rate with the target at 0.25% and has turned to what is called "quantitative easing"--the buying of longer-term mortgage-backed and Treasury securities in the market. If any kind of hint is given in the Fed statement on movement in this area, it will be news. On the rate front, market participants expect their posture of keeping rates low for an extended period (until employment shows meaningful improvement) will remain in place.

Stay tuned.


  1. If the Feds decided to purchase more mortgage-backed securities, will there be an impact on the interest rates for 30-year mortgage? If so, would you please explain.

  2. re: Shawn If the Fed buys more mortgage-backed securities it should push the price of those bonds higher and thus their yields lower. This would cause mortgage rates to move somewhat lower as long as inflation remains well behaved. From a longer-term perspective it puts more excess reserves in the banking system. Once banks start to lend it will put more money in the system and inflation pressures will build. This whole process is called "monetizing the debt".
    What has a lot of people bothered is that the Fed seems to just have a short-term outlook and isn't concerned about the longer term impact of its actions.

  3. Thanks for the explanation,

    It's hard to imagine interest rates going much lower than they presently are.


  4. What do you think will be the outcome of QE2? Didn't the BoJ just intervene since they felt that the yen was too high versus the dollar? Interesting that there wasn't too much of a big deal made out of that when the US administration is currently making a big deal over China holding down the renminbi.

  5. re: Kevin I think QE2 is a bad idea. I think the Fed needs to quit manipulating markets. A number of commentators are noting the difference between the reactions with respect to Japan and China.

  6. Tomorrow the market will break out higher or tumble. The Fed will have to choose its wording very carefully!

    ...Then we have all the housing data coming, nothing rosy to be expected.

  7. You gave me a chuckle Robert - not a fan of "talking heads" either?

    "If you are interested in the 3 ring circus surrounding this event, tune into CNBC at 2:10 pm, or so to see the usual talking heads"....

    Just noise, after all, isn't it?

    Mark from My Own Advisor

  8. I don't expect much change in interest rate policy until housing starts showing signs of recovery or inflation kicks up.

  9. I don't think the market is going to do much after FOMC because I don't think there will be a surprise. Of course, if they announced a QE move or raised the fed funds target rate 25 basis points there would be a market impact. My best guess is that a QE announcement will come at the next meeting if the economic data deteriorates further.
    More important this week, I think, is the initial unemployment claims released Thursday morning.