Who Determines Interest Rates?
FOMC Texas Style Showdown
The Federal Open Market Committee meets eight times a year to determine the direction of monetary policy. Basically, they get together in a secret room and decide whether to raise, cut, or do nothing with the federal funds rate. Nobody outside of the 12 members on the Federal Reserve Board are allowed in so as far as we know they might have monkeys randomly throwing darts to determine where interest rates are going. That might sound crazy but it’s what I’m going with until anyone can prove otherwise.
Anyway, back to the topic. Jerome Powell, the Chairman of the Fed, is most known in colloquial circles as the guy on all the finance meme pages making the “money printer go brrrrr” during the pandemic. Indeed, Powell was focused on loosening monetary policy in those days to spur the economy but times have changed. Since last March, the Fed has embarked on a series of rate hikes (10 to be exact) with the most recent being back at the May meeting. Market participants are on the edge of their seats as they await the Fed’s move June 14. For finance nerds this meeting is like Vegas and the rate decision is the hottest table in the casino. Investors across equity and bond markets try to bet on which way the Fed is leaning. Members of the board are allowed to speak publicly, expressing their individual opinions on whether an increase, decrease, or pause is appropriate. Markets will move, pretty violently sometimes, based on their rhetoric. However, 10 days before the meeting takes place, board members enter a blackout period where they cannot express any of their views to the public, and that is where the fun really begins.
The dot plot, appropriately named, is a plot of 19 dots. Seven members of the Board of Governors of the Federal Reserve System and presidents of the 12 regional banks are asked to indicate where they believe the Federal Funds rate should be in the future. Banks will also throw their cards out on the table and take part in the game as well. As it stands now, the consensus for the June meeting is for the Fed to do nothing and leave rates be. After that, bets are all over the place. Some banks, like Barclays are projecting two additional rate hikes while others call for a continued pause. However, jumping over to the bond market we can see it is predicting a rate cut.
Ultimately, the Fed will synthesize all of the macroeconomic data they have on hand since the last meeting to make the decision they feel best balances out lowering inflation while avoiding a recession. This data includes: Unemployment rates, household income, house prices, inflation, jobless claims, etc. Just like in the casino, some investors will be right and others wrong and there is a lot of money to be made or lost. Fortunately, we have the luxury of being able to pontificate from the sidelines with no real skin in the game. Let’s all sit back and watch!
