In today's lesson we are going to look at how the Fed goes about
signaling to the market changes in their thinking on the direction of
monetary policy, so we can begin to understand why markets react not
only to Fed interest rate announcements but just as importantly to
events which change the markets anticipation of how the Fed may react.
While we have simplified the situation in order to better understand the
basics of how The Fed uses monetary policy, as you can probably tell by
now, forecasting economic conditions and using monetary policy to try
and manage those conditions is a very difficult process. The members of
the FOMC are constantly analyzing economic data from across the country
to try and gauge where the economy is in the business cycle and what if
any monetary policy action is needed.
The FOMC has 8 regularly scheduled meetings throughout the year where they meet to discuss current economic conditions and expectations of future conditions. It is at these meetings that decisions on what changes if any in monetary policy need to be made. Upon completion of these meetings a press released is issued.
What the FOMC decides to do with their target for Fed Funds Rate at this
meeting has wide ramifications for the economy and therefore the
markets. With this in mind the results of these meetings are closely
followed by market participants. It is important to understand however
that the market not only looks for whether or not the FOMC takes action
on the Fed Funds Rate and by how much, but also for any clues in the
Fed's Statement as to what their bias may be for future rate decisions.
This
is a very key point to understand because the markets are always trying
to anticipate what is going to happen and therefore they move up and
down depending on what people think will happen to rates going forward.
Anything that comes out from this meeting or any thing else that is in
line with what the market expects should have little or no effect on the
market. Conversely anything that comes out which changes the markets
forecasts on what if any Fed action will be, can cause drastic moves in
the markets as participants react to this new information and markets
adjust accordingly.