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FOMC Meeting: What You Need to Know
The Federal Open Market Committee (FOMC) meetings in 2016 so far have all left interest rates unchanged. However, that hasn't stopped the guessing game that always surrounds the FOMC meeting: will the Federal Reserve interest rate be hiked this year or next? Will they remain the same? Will they be cut?
The FOMC is a body made up of seven members of the Board of Governors of the Federal Reserve system and five presidents of the individual regional Reserve Banks. The FOMC debates monetary policy at its roughly eight regular meetings per year.
The FOMC meeting's decision to raise, cut, or leave rates unchanged is informed by Federal Reserve member data about economic conditions around the country. There are a number of economic indicators that are accounted for, including jobs, inflation, business and consumer economic behavior, and the direction of economies and rates overseas.
The FOMC meeting decisions, whether issued in announcements or via FOMC minutes, have huge impacts on the markets and the economy. A cut in rates is often intended as economic stimulus, while raising them indicates the economy is on a solid footing. There is also an art to not raising rates, think of it like not slamming the brakes on a recovering economy. Fed Chair Janet Yellow has indicated that she wants to raise rates slowly going forward, if at all.
Last December, for example, the FOMC hiked rates for the first time in 10 years. The Fed believed the economy had emerged sufficiently from the Great Recession and that the employment picture indicated a recovering economy. The Fed pointed to 5% unemployment (a figure economists consider close to full employment), and adequate inflation numbers, as key reasons for the rate hike.
At that point, the Fed also signaled that they planned to raise rates four times at FOMC meetings in the coming year.
The stock market, however, dropped 10% during the first six weeks of 2016. The interest rate hike moved the rate to 0.50%, which was still historically low. But a hike in rates can have a negative effect on markets, because investors worry that the Fed will overdo hikes in interest rates once they start to climb.
Some fear the negative effects of a rising U.S. dollar, which is a connectedof rate hikes. Some react to the effect on businesses that carry debt, which becomes more expensive when rates advance. Some react negatively to a new and uncertain factor in the market environment. Concerns about the slowing Chinese economy, slackening global economies, and oil prices were also factors affecting the market's decline.
While we saw a rate hike at the end of 2016, we still haven't seen one in 2016. Here's why…
Early in 2016, the Fed was widely expected to raise interest rates during the year.
But after each meeting, the Fed has refused to raise rates. For the first FOMC meeting in late January, the FOMC announcement cited slowing economic growth, moderate spending in households and business investment, soft exports and inventory investments, inflation below the Fed's 2% target, and the effect of global economies on inflation and jobs. It did indicate that projected economic growth would provide a backdrop for an accommodative stance (ie, hikes). However, the FOMC decision to leave rates unchanged also indicated that growth was not perceived as being as strong as it needed to be.
At the next FOMC meeting, in mid-March, inflation was cited. It was still below the 2% Fed target, and Yellen said that it is not expected to hit that target fully until two or three years out. Inflation was driven by the advances in the price of West Texas Intermediate (WTI), which rose nearly 20% in the period, and consumer price increases, which registered their largest rise in four years, at 1.3%.
During the same period, the European Central Bank (ECB) lowered interest rates in the Eurozone to 0% from 0.05%. (The Eurozone consists of 19 of the 28 European Union (EU) countries that use the euro as currency.)
When the ECB and Fed policies are divergent (one lowering and the other signaling future climbs), it can create an environment where the U.S. dollar rises as well. That could negatively impact U.S.-based companies with overseas businesses. Yellen noted that the FOMC was monitoring the path of the dollar.
At that point, economists were still forecasting a minimum of two small 0.25% increases in rates during 2016. The CME set the chances at 51%. But a profoundly glum May jobs report – the worst since 2010 – derailed that idea. In the mid-June FOMC meeting, the Fed left rates unchanged. The reasons given were the slowing improvement in the jobs market. Other economic indicators, including increases in household spending and the housing market, were strong, but not strong enough to counterbalance dismal job creation.
At that point, Federal Reserve officials reiterated its goal of an accommodative approach and signaled that it expected to raise rates once in 2016 and three to four times during 2017.
The Fed minutes from the June FOMC meeting, released in early July, indicate that the Fed was also very concerned about the potential impact of Brexit. The British vote to leave the European Union (EU) leaves a significant economic overhang that could take years to unfold, so the Fed did not want to add to the global uncertainty or to an economic slowdown in the wake of the vote.
Brexit was still a major issue in the late July FOMC meeting, which also saw rates left unchanged. In late June (after the June FOMC meeting), UK voters turned in a narrow margin of victory to the "leave" side of the Brexit equation, which means that UK and EU lawmakers will be negotiating the terms of the leave for at least two years (per EU requirements). Prior to the July FOMC meeting, the CME FedWatch indicated a 25.2% chance that the Fed would hike rates in September and 26.3% in November. Those numbers would end up falling though toward the end of the summer.
At this point, prognosticators don't expect a Fed rate hike in 2016, and possibly not until the first or second quarter of 2017. As the months have gone on, three primary economic culprits have emerged: 1) global volatility in the stock markets, 2) weak global economic data, and 3) the impact of Brexit.
First, although U.S. markets are making new highs, they are subject to volatility because of the uncertainty of the global economy, uncertainty about the U.S. presidential election, and the impact of Brexit. Globally, markets were hammered by Brexit and while some have recovered, volatility still remains a danger given uninspired economic performance and uncertainty worldwide.
Global economic data is also weak. Many European countries have prepared stimulus packages and have rates at 0% or less. China, although growing robustly by Western standards at more than 5%, is concerned that its rapid growth is slowing.
Brexit is also expected to have an impact worldwide, on three fronts.
First is the sheer economic impact itself. Prior to the Brexit vote, the Bank of England and other pillars of British finance came out in the "Remain" camp, cautioning voters that stepping outside the EU could result in a weakening economy and a poorer employment picture. International organizations like the International Monetary Fund and the Organisation for Economic Cooperation and Development (OECD) also came out on the "remain" side. In leaving the EU, the UK will be forfeiting economic benefits that came along with being an EU member nation, such as tariff rates, trade agreements, access to markets, and cross-border movement of goods and labor.
In addition, less favorable access in the UK vis-à-vis European markets could have an impact on all the UK and EU trading partners globally, including those in the US.
The outcome of Brexit is likely to affect economic growth worldwide. It is not an event affecting only a few places in Europe. Shortly after the vote, for example, Barclays Plc. (NYSE: BCS) projected that the Chinese gross domestic product will likely shrink one-tenth of a point in 2016 and 2017 due to the effects of Brexit alone. The Chinese stock market fell 1% in the wake of Brexit, and the Chinese government devalued the yuan.
Goldman Sachs Group Inc. (NYSE: GS) issued a report in the wake of Brexit that the devaluation will impede Chinese efforts to stop its capital outflows, which hit $175 billion between January and May of this year.
The second front is what might be termed the larger impact of Brexit. It seems a potential harbinger of global economic disunity and a backing away from the trend of freer global trade and cooperation worldwide. Huang Yiping, one of the members of the central bank monetary policy committee in China, said it seems like a "reversal of globalization," and cautioned that the vote could have "very bad" global repercussions for the world. China's Finance Minister, Lou Jiwei, told the BBC that Brexit has "cast a shadow over the global economy," and that the shadow will last for years.
The long-term fate of the EU is itself in question. The loss of one country may ultimately give other EU member countries ideas of leaving. Several countries within the EU, for example, have huge debts and huge debt service requirements. They may decide to renegotiate, or simply to leave. The loss of a strong member like the UK in some ways may make the EU weaker. Or, it may give other economically strong members, such as Germany, more power within the EU. It may use this power to negotiate different policies than currently favored.
In short, Brexit may signal the beginning of a different EU: either a stagnant one, a faltering one, or one renewed with different policy relations.
That leads to the third front. Markets hate uncertainty. Given the far-ranging nature of possible effects, the protracted negotiations (two years minimum), and the multiplicity of fronts the negotiators face, Brexit uncertainty will be a factor in the markets for some time.
Brexit nearly single-handedly overturned the consensus among traders that the Fed would raise rates once during 2016. Currently, consensus indicates that the chances of U.S. rates being moved down is larger than the probability they move up.
Investors need to know how to invest given the chances that the FOMC meetings near term mean a continuation of a low interest rate environment with market uncertainty. In January, Money Morning Chief Investment Strategist Keith Fitz-Gerald reiterated that there are opportunities in every market. He reminded investors that during times of low-rates the markets are the most powerful wealth-creation tool available to help protect and grow your retirement. Fitz-Gerald said it's important to keep your eyes on the big picture and if possible, to stay in the game.
Fitz-Gerald recommends that investors think in terms of portfolio structure. He recommends that investors create a pyramid-structured portfolio that is based on investment type, with allocations of 50%, 40%, and 10%.
The 50% is put toward "foundational" investments. These are picked for a solid base and their ability to not be driven by volatility. Foundational plays are companies whose products will be purchased regardless of the economic picture. They are also "dividend aristocrats" – companies that have a multi-decade record of growing their dividend payout and whose yields are often better than investors can obtain through the bond market.
The 40% is devoted to growth investments. They are globally engaged companies with strong balance sheets, and products that will benefit from Fitz-Gerald's Unstoppable Trends. (These are medicine, technology, demographics, energy, war/terrorism/ugliness, and scarcity.) They provide products and services that businesses and consumers consider must haves. Many are also income stocks and dividend aristocrats as well.
For the 10%, investors can invest in companies that will move up based on a specific catalyst. It could be government approval of a new product, an initial public offering of a promising company, an acquisition, or a new patent.
The direction of markets often depends on the direction of the FOMC meetings. Stay tuned to the news out of FOMC meetings by following Money Morning analysts. Sign up for customized stock picks from the greatest stock pickers in the industry.
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The FOMC meeting is where the policymaking body of the Federal Reserve System meets to discuss the current state of the economy. It's comprised of 12 members, and holds eight scheduled meetings during the year. It can also meet outside of the scheduled times if needed. After the FOMC meeting, a policy statement is issued to summarize policy decisions at the meeting.
The 2016 FOMC meeting calendar includes all the dates the FOMC met or is set to meet. The 2016 FOMC meeting calendar included one meeting in January, one meeting in March, one meeting in April, one meeting in June, and one meeting in July. There will be additional FOMC meetings on Sept. 20-21, November 1-2, and Dec. 13-14. The FOMC has scheduled eight meetings for 2017.
The markets don't believe that the Fed will raise interest rates after any 2016 FOMC meeting. According to CME Group's FedWatch Tool, there is only a 12% chance rates are raised after the September FOMC meeting. For November, there is only a 19.3% chance rates are raised. The closest chance of a rate hike happening in 2016 is after the December FOMC meeting, where only 50.1% of investors believe the Fed will raise interest rates.