How well do you know the Fed?
- What does FOMC stand for?
- How many members comprise the FOMC?
- True or false: Congress has to approve the FOMC’s monetary policy decisions.
- True or false: The FOMC’s economic goals are maximum employment and price stability.
- Which state has two Federal Reserve Banks?
- Who is the vice chair of the FOMC?
Hopefully you got a passing grade (you can check your score at the bottom of this post), but how many of these questions do you think your clients could answer correctly? The U.S. Federal Reserve (the Fed) is a highly influential decision-making body that has received no shortage of media coverage in recent years. And yet, many investors likely don’t know who “the Fed” really is, what they do and how to interpret their actions.
And this is important. After seven years of near-zero interest rates the Fed finally hiked short-term interest rates in December 2015 and signalled that it expected gradual increases in 2016. Since that time, however, market volatility has created considerable uncertainty around what the Fed will do next. To help make sense of it all, let’s go back to basics.
In the face of a wave of economic panic in the early 1900s, the Federal Reserve was created in 1913 to act as a “lender of last resort” to the U.S. banking system. But the Fed’s responsibilities have grown over the last century. Today, when we talk about the Fed we’re typically talking about the Federal Open Market Committee (FOMC), which is the Fed’s primary decision-making body for monetary policy.
Right now, all eyes are on the FOMC’s decisions around the federal funds rate, which is the overnight interest rate at which banks lend to each other. By moving this interest rate up and down the Fed is able to speed up and slow down the economy in line with what it considers to be sustainable and optimal over the long term.
The FOMC typically consists of 12 members: seven members of the Board of Governors of the Federal Reserve System (including the chair), the president of the Federal Reserve Bank of New York and four of the 11 other Reserve Bank presidents, who serve on a rotating basis.1 They come together for eight meetings a year in Washington, D.C. In 2016, those meeting dates are in January, March, April, June, July, September, November and December.
These meetings are widely watched by those looking for clues about the Fed’s interest rate decisions as they aim to balance economic growth and inflationary fears. At each meeting, members discuss developments in the markets and their own economic forecasts. The members debate viable monetary policy options and then vote to either maintain or alter the current policy.
But just who are these members? You’re probably familiar with Federal Reserve Chair Janet Yellen. Yellen has considerable expertise and influence over the Fed’s decisions, but many of the other FOMC members regularly voice their views in the media, which can create confusion for investors.
To help synthesise all of the Fed chatter, I created the following “who’s who” guide to the current voting members on the FOMC. These evaluations are my own personal opinion, but this summary might be helpful in your next client conversation about the outlook for Fed policy and the future path of interest rates.
2016 voting members shown. Bold text denotes comments made since the last FOMC statement.
The “star” rating represents how influential each member is in determining monetary policy. You might know Yellen, but are you familiar with other highly influential figures such as Stanley Fischer, the vice chairman of the U.S. Federal Reserve Board of Governors? Fischer’s CV includes positions like chief economist at the World Bank and the head of the Bank of Israel. Fischer also taught many of the world’s most famous central bankers as a professor at the Massachusetts Institute of Technology (MIT) – including former Fed Chair Ben Bernanke and current European Central Bank President Mario Draghi.
Some FOMC members are “dovish” — meaning that they generally prioritise stronger economic growth and employment over raising interest rates. Other FOMC members are “hawkish,” prioritising rate hikes to combat current or expected inflation. Where members fall on this dove-hawk philosophical spectrum influences their views on 2016 interest rate hikes as well as the type of insight they share with the media, as captured in their key quotes.
So, we have 10 people with very different views. It can be hard to understand how they come together to make decisions. My fellow investment strategists at Russell Investments and I think about a “three-legged stool” that seems to influence Fed action. Those “legs” are:
- Actual inflation
- Medium-term outlook
We believe that two of these legs, employment and actual inflation, are fairly solid today. The U.S. unemployment rate stands below 5% and measures of wage and price inflation appear on track towards the Fed’s two percent inflation target. The wobbly leg is the medium-term outlook. Financial markets remain very volatile and it appears difficult for the Fed to properly assess what, if any, impact this volatility will have on the real economy.
As the quotes in the table above show, most FOMC members have vocalised a “wait and see” mode in the face of current market volatility. Against this backdrop, we don’t expect the Fed to raise interest rates at their meeting on March 16. That being said, we do continue to hold a cautiously positive medium-term outlook on the U.S. economy and with actual inflation starting to pick up a bit, we still anticipate two gradual rate increases later in the year.
The bottom line
The FOMC is clearly a complex group making complex decisions — so why should investors bother to learn the basics? I think that developing a better understanding can help investors interpret the flurry of activity, opinion and market movement that can be generated by FOMC decisions (or lack thereof). Educating your clients can enable them to manage headline-driven anxieties and understand how an increasing interest rate environment might impact investment decisions.
- Federal Open Market Committee
- Normally 12. However, two of the seats in D.C. are currently vacant.
- However, the Fed is still subject to oversight by Congress, which can make changes statutorily.
- There are twelve Regional Federal Reserve Banks in the United States. Oddly enough, two of them – Kansas City and St. Louis – are located in Missouri.
- Okay, this is a bit of a trick question. The answer is William Dudley because the President of the New York Fed always serves as vice chair of the FOMC. Stanley Fischer is vice chair of the Federal Reserve Board in D.C.
1 Source: Federal Reserve Bank of St. Louis. In Plain English: Making Sense of the Federal Reserve
- Yellen: Semiannual Monetary Policy Report to the Congress. Feb. 10, 2016.
- Fischer: “Energy Transition: Strategies for a New World,” 35th Annual IHS CERAWeek, Houston, Texas. Feb. 23, 2016.
- Dudley: Remarks at the New York Fed’s Economic Press Briefing, Federal Reserve Bank of New York, New York City. Feb. 12, 216.
- Brainard: 2016 Monetary Policy Forum conference.February 26, 2016.• Powell:“A conversation with a Federal Reserve Governor.” Marketplace Dec. 18, 2015.
- Tarullo: “Fed’s Tarullo Remains Worried by Low Inflation Despite Job Gains.”
Bloomberg. Nov. 23, 2015.
- Mester: “The Economy and Monetary Policy.”
Federal Reserve Bank of Cleveland. Feb. 19, 2016.
- Bullard: “St. Louis Fed’s Bullard Discusses Changing Imperatives for U.S. Monetary Policy Normalization.”
Federal Reserve Bank of St. Louis. Feb 17, 2016.
- Rosengren: “Prospects for Returning to More Conventional Monetary Policy.”
Federal Reserve Bank of Boston. Feb. 16, 2016.
- George: : “The U.S. Outlook and Monetary Policy.”
Federal Reserve Bank of Kansas City. Feb. 2, 2016.
Issued by Russell Investment Management Ltd ABN 53 068 338 974, AFS Licence 247185 (“RIM”). This document provides general information only and has not been prepared having regard to your objectives, financial situation or needs. Before making an investment decision, you need to consider whether this information is appropriate to your objectives, financial situation and needs. This information has been compiled from sources considered to be reliable, but is not guaranteed. Past performance is not a reliable indicator of future performance. Any potential investor should consider the latest Product Disclosure Statement (“PDS”) in deciding whether to acquire, or to continue to hold, an investment in any Russell product. The PDS can be obtained by visiting www.russell.com.au or by phoning (02) 9229 5111. RIM is part of Russell Investments (“Russell”). Russell or its associates, officers or employees may have interests in the financial products referred to in this information by acting in various roles including broker or adviser, and may receive fees, brokerage or commissions for acting in these capacities. In addition, Russell or its associates, officers or employees may buy or sell the financial products as principal or agent. Copyright 2016. Russell Investments. All rights reserved. . This material is proprietary and may not be reproduced, transferred or distributed in any form without prior written permission from Russell Investments.