demystifying the federal open markets committee...composition of the fomc 7 fed governors 5 of 12...

Demystifying the Federal Open Markets Committee

Shailesh N. Mulki, FRM

Corporate Risk Manager

Western Union Business Solutions

July 2015

2

The views expressed in the following material are the

author’s and do not necessarily represent the views of

the Global Association of Risk Professionals (GARP),

its Membership or its Management.

The FOMC In the limelight this year

Last rate hike in June 2006

Rate Hike – this year? Or Next ? Or ?

The Federal Reserve System Set up in 1913 by the Congress

Functions

Conducting Monetary Policy

Supervising & Regulating Banks

Maintaining the stability of the banking system

Providing financial services to the US Government, depository institutions, foreign official institutions, playing a major role in operating the nation’s payment system

Source: US Federal Reserve

The Federal Reserve – Structure Board of Governors

Appointed by the President Confirmed by the Senate Term of 14 years Staggered appointments to ensure continuity

Current Composition Janet Yellen –Chairperson Stanley Fischer – Vice Chairman Daniel K. Tarullo Jerome H. Powell Lael Brainard 2 vacancies currently


Twelve Federal Reserve Banks


Reserve Banks All Nationally Chartered Banks hold stock in the Regional Federal

Reserve Bank in their district State Chartered Banks can be members based on certain thresholds Each banks owns stock based in its own net equity. The stock is unlike the stock of any US corporation. The stock pays dividend ? Each Regional Federal Reserve Bank Board has 9 members

3 are elected by the Regional Reserve Bank’s shareholders 3 are nominated by the Regional Reserve Bank’s shareholders to

represent the interest of the public 3 are nominated by the Board of Governors and are expected to

represented the interest of the public

The President of each Regional Federal Reserve Bank is nominated by the Board but this has to be approved by the Board of Governors.


How is the Federal Reserve funded?

Interest on U.S. government securities that it trades through open market operations.

Interest on foreign currency investments held by the System;

Fees received for services provided to depository institutions, such as check clearing, funds transfers, and automated clearinghouse operations; and

Interest on loans to depository institutions (the rate on which is the so-called discount rate).

After paying its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury.


Fed Transfers to Treasury


Year Amount transferred to Treasury

2014 $98.7 billion

2013 $77.7 billion

2012 $88.9 billion

2011 $76.9 billion

2010 $78.4 billion

2009 $46.1 billion

2008 $34.9 billion

2007 $34.4 billion

2006 $28.5 billion

2005 $21.4 billion

FOMC Responsible for setting Monetary Policy

Federal Open Market Committee is responsible for open market operations.

Sets the Federal Funds rate

What is the Federal Funds rate?


Composition of the FOMC 7 Fed Governors

5 of 12 Federal Reserve Bank Presidents

The President of the NY Fed has a permanent voting seat on the FOMC

Of the remaining 11 Federal Reserve Bank Presidents 4 have voting powers each year on a rotational basis

Currently 5+5 voting members

All Federal Reserve Bank Presidents are members of the FOMC and participate in all discussions


Current Year Voting Members Federal Reserve Bank of Richmond President Jeffery Lacker

Federal Reserve Bank of Atlanta President Dennis Lockhart

Federal Reserve Bank of San Francisco President John Williams

Federal Reserve Bank of Chicago President Charles Evans

Federal Reserve Bank of New York President William Dudley (FOMC Vice Chair)


Goal of Monetary Policy Maximum unemployment

No quantified number

Stable prices & moderate long-term interest rates

Current Inflation target – 2%


FOMC Meeting Process Number of meetings each year

Meetings on Phone - Sept 13,2001

Quorum for each meeting

Meeting Schedule announced in Q2 for the following year


Decision Making Presentation by Federal Reserve Staff

Views of each FOMC member including non-voting members

Second round of views with explicit policy recommendations


Statement Consensus on the statement

The concept of “Dissenting Vote”

Where to find this? http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm

Minutes of this meeting is released about 3 weeks after the meeting is held

Every Alternate meeting the FOMC releases “Projection Materials”


http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm

http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm

Structure of the FOMC Statement June 17,2015 Para 1 – Current state of the economy

Economic activity – “expanding moderately after having changed little during the first quarter”

Labor market – “underutilization of labor resources diminished somewhat”

Household spending – “has been moderate”

Housing sector – “has shown some improvement”

Business fixed investment & net exports – “soft”

Inflation – “continued to run below the Committee’s longer-run objective”


Structure of the FOMC Statement Para 2 – Current Outlook compared to the dual mandate Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of earlier declines in energy and import prices dissipate. The Committee continues to monitor inflation developments closely.


Structure of the FOMC Statement Para 3 – Policy rate changes moves & reasons for this. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term


Structure of the FOMC Statement

Para 4 – Continuation from the QE days

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.


Structure of the FOMC Statement

Para 5 - Forward looking view

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.


Structure of the FOMC Statement Para 6 - Voting details along with any dissents and reasons for such

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M. Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams.


Dovish & Hawkish – What does this mean? Market participants based on the views and comments

from the FOMC members classify the FOMC members as “Doves” or “Hawks.”

Dovish

Hawkish

FOMC members are generally well regarded professionals & academicians who have been in the public domain for some time and their views on economic policy are well known.


Projection Material – GDP, Unemployment rate & PCE Inflation


Projection Material Appropriate timing of policy firming


Projection Material – “Dot Plots”


How are Fed Futures pricing Fed Rate hikes ?

Source: CME Group

Meeting Date Probability of Rate Hike

17-Sep-15 13.90%

28-Oct-15 28.00%

16-Dec-15 50.00%

27-Jan-16 64.70%

16-Mar-16 75.30%

27-Apr-16 84.50%

15-Jun-16 90.30%

Views of Key FOMC Members The three key members Janet Yellen – Fed & FOMC Chair – most dovish Fed Chair ever? tilt towards keeping

rates low to support the labor market recovery in an environment of low inflation. Has raised concerns about the slack in labor market.

William Dudley – FOMC Vice Chair – Had a reputation of being slightly dovish. Has sounded cautious of a early lift off in rates in April. Had initially called for a rate hike mid-year but had raised concerns after soft economic data in Q1. Was quoted in June saying “Sept rate hike is very much in play” if the US economy continues to strengthen, though the fed could wait until December to start tightening policy

Stanley Fischer – Fed Vice-Chair – a slightly Hawkish last week when he said “tentative signs of wage growth” and continued job creation gave him the confidence that US labor market will continue improving & gradually push inflation towards the Fed’s 2% target. He did not directly speak about the first rate hike, but mentioned that the Central Bank needed to stay ahead of the curve since monetary policy only affects the economy with a time lag.

Views of Key FOMC Members The Federal Reserve Governors

Governor Daniel K. Tarullo– neither “dove” nor “hawk” Focused more on regulation and policy

Governor Jerome H. Powell– End June was quoted as saying that 2 rate hikes in 2015 is possible if the Fed’s economic forecast actually unfolds & a 50% chance of a rate hike in Sept

Governor Lael Brainard – Has “Dovish outlook” US economy too fragile to handle interest rate increases. Raised concerns about the recent economic weakness which may not be transitory

Views of Key FOMC Members The Voting Member from the Federal Reserve banks Richmond Fed President Jeffery Lacker – one of the most hawkish members of

the FOMC currently. He dissented at every meeting in 2012. He did not agree but has gone with the majority so far this year.

Atlanta Fed President Dennis Lockhart He has a mildly dovish view and in early April commented that “murky” data has him learning against a June rate hike and will seek confirmation from incoming data

San Francisco Fed President John Williams – T-shirt with wordings “Monetary Policy – It’s Data Dependent.” Last week he reiterated his expectations for two rate hikes in 2015 and he expects that there would be enough data for the FOMC to take a call, with the Fed's employment goal "in sight" with the labor market making good progress across a broad range of indicators

Chicago Fed President Charles Evans – Quiet clearly the most dovish member of the current FOMC has stated in early May that rate hikes should be pushed into next year.

Current Economic Scenario Data that directly relates to the dual mandate

Employment

Inflation

Broader Growth

GDP

Retail Sales

Household Spending

Housing Sector

Business Investments

International Trade

Jobs added Non-Farm Payroll

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000Ja

n-1

4

Feb

-14

Mar

-14

Ap

r-1

4

May

-14

Jun

-14

Jul-

14

Au

g-1

4

Sep

-14

Oct

-14

No

v-1

4

De

c-1

4

Jan

-15

Feb

-15

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Source: Thomson Reuters

Unemployment Rate

0

2

4

6

8

10

12

Jan

-05

May

-05

Sep

-05

Jan

-06

May

-06

Sep

-06

Jan

-07

May

-07

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Jan

-10

May

-10

Sep

-10

Jan

-11

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

High of 10%

Low of 4.4%

Currently at 5.3%


Broader Unemployment Rate U-6

© 2015 Western Union Holdings Inc. All rights reserved. 33

Source: Bureau of Labor Statistics

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

Jan

-05

May

-05

Sep

-05

Jan

-06

May

-06

Sep

-06

Jan

-07

May

-07

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Jan

-10

May

-10

Sep

-10

Jan

-11

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

High of 17.1% in Oct 2009-April

Low of 7.9% in Dec 2006

Currently at 10.5%

Full Time employment has not yet recovered to pre-crisis highs

Participation Rate



60.0

61.0

62.0

63.0

64.0

65.0

66.0

67.0Ja

n-0

5

May

-05

Sep

-05

Jan

-06

May

-06

Sep

-06

Jan

-07

May

-07

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Jan

-10

May

-10

Sep

-10

Jan

-11

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

Lowest of 62.7%

Highest of 66.4%

Wage inflation in benign

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Jan

-00

Jul-

00

Jan

-01

Jul-

01

Jan

-02

Jul-

02

Jan

-03

Jul-

03

Jan

-04

Jul-

04

Jan

-05

Jul-

05

Jan

-06

Jul-

06

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

Jan

-11

Jul-

11

Jan

-12

Jul-

12

Jan

-13

Jul-

13

Jan

-14

Jul-

14

Jan

-15

During the last rate hike cycle


Inflation - CPI



-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Mar

-10

May

-10

Jul-

10

Sep

-10

No

v-10

Jan

-11

Mar

-11

May

-11

Jul-

11

Sep

-11

No

v-11

Jan

-12

Mar

-12

May

-12

Jul-

12

Sep

-12

No

v-12

Jan

-13

Mar

-13

May

-13

Jul-

13

Sep

-13

No

v-13

Jan

-14

Mar

-14

May

-14

Jul-

14

Sep

-14

No

v-14

Jan

-15

Mar

-15

May

-15

Inflation -PPI



-2

-1

0

1

2

3

4

5D

ec-

10

Mar

-11

Jun

-11

Sep

-11

De

c-1

1

Mar

-12

Jun

-12

Sep

-12

De

c-1

2

Mar

-13

Jun

-13

Sep

-13

De

c-1

3

Mar

-14

Jun

-14

Sep

-14

De

c-1

4

Mar

-15

PCE – Inflation

© 2014 Western Union Holdings, Inc. All Rights Reserved. Western Union Confidential 39

Source: Federal Reserve bank of St. Louis, US Bureau of Economic Analysis

0

0.5

1

1.5

2

2.5

US GDP Growth - Post the Financial Crisis


Source: Federal Reserve Bank of St. Louis, Bureau of Economic Analysis

2008 2009 2010 2011 2012 2013 2014

GDP -0.3 -2.8 2.5 1.6 2.3 2.2 2.4

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

GDP – Downward revisions to 2015 expectations

41

Expectations for 2015 GDP growth as per FOMC forecast is 1.8-2.0%

Source: US Department of Commerce, Bureau of Economic Analysis

-3

-2

-1

0

1

2

3

4

5

6

Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015

Retail Sales



-1.5

-1

-0.5

0

0.5

1

1.5

2

Savings Rate


Source –Federal Reserve Bank of St. Louis, US. Bureau of Economic Analysis

3

3.5

4

4.5

5

5.5

6

Housing

“Historically, residential investment has averaged roughly 5% of GDP while housing services have averaged between 12% and 13%, for a combined 17% to 18% of GDP. These shares tend to vary over the business cycle” - National Association of Home Builders


New Home Sales

-

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

Jan

-90

No

v-9

0

Sep

-91

Jul-

92

May

-93

Mar

-94

Jan

-95

No

v-9

5

Sep

-96

Jul-

97

May

-98

Mar

-99

Jan

-00

No

v-0

0

Sep

-01

Jul-

02

May

-03

Mar

-04

Jan

-05

No

v-0

5

Sep

-06

Jul-

07

May

-08

Mar

-09

Jan

-10

No

v-10

Sep

-11

Jul-

12

May

-13

Mar

-14

Jan

-15


Peak 1.389 m

July 2005

Low 270k Feb 2011

May 546k

Existing Home Sales


-

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

Jul-

95

Mar

-96

No

v-9

6

Jul-

97

Mar

-98

No

v-9

8

Jul-

99

Mar

-00

No

v-0

0

Jul-

01

Mar

-02

No

v-0

2

Jul-

03

Mar

-04

No

v-0

4

Jul-

05

Mar

-06

No

v-0

6

Jul-

07

Mar

-08

No

v-0

8

Jul-

09

Mar

-10

No

v-10

Jul-

11

Mar

-12

No

v-12

Jul-

13

Mar

-14

No

v-14

Peak 7.25 million Sept 2005

Low 3.45 million July 2010

May 5.35 million

S&P/Case-Shiller Price Index

© 2014 Western Union Holdings, Inc. All Rights Reserved. Western Union Confidential 47


-25

-20

-15

-10

-5

0

5

10

15

20

Jan

-01

Jul-

01

Jan

-02

Jul-

02

Jan

-03

Jul-

03

Jan

-04

Jul-

04

Jan

-05

Jul-

05

Jan

-06

Jul-

06

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

Jan

-11

Jul-

11

Jan

-12

Jul-

12

Jan

-13

Jul-

13

Jan

-14

Jul-

14

Jan

-15

Durable Goods Orders

-25

-20

-15

-10

-5

0

5

10

15

20

25


US – Industrial Production



-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2Ja

n-1

3

Feb

-13

Mar

-13

Ap

r-13

May

-13

Jun

-13

Jul-

13

Au

g-1

3

Sep

-13

Oct

-13

No

v-13

Dec

-13

Jan

-14

Feb

-14

Mar

-14

Ap

r-14

May

-14

Jun

-14

Jul-

14

Au

g-1

4

Sep

-14

Oct

-14

No

v-14

Dec

-14

Jan

-15

Feb

-15

Mar

-15

Ap

r-15

May

-15

Trade Deficit

30

35

40

45

50

55


Fed Funds rate till date

0

1

2

3

4

5

6

7

17 meetings and 25 months for rates to move from 1% to 5.25%

14 months for rates to be cut from 5.25% to 0.125%


demystifying the federal open markets committee...composition of the fomc 7 fed governors 5 of 12...

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