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Interpreting Federal Reserve Communications

If you feel as though the Federal Reserve’s every utterance is breaking news, you’re right. In 1999, the Fed began issuing statements after each Federal Open Market Committee (FOMC) meeting, where its 12 voting members set U.S. interest-rate policy through the federal funds rate—the interest rate banks and credit unions charge each other to lend Federal Reserve funds overnight. Since then, the Fed has been working to become even more transparent, issuing not only statements but also meeting notes and conclusions.

All that candor is a welcome change from the days when analysts and investors were forced to divine policy from open market operations—the central bank’s buying and selling of U.S. government securities to regulate the amount of money in the banking system.

However, many critics believe the Fed now overcommunicates, with its individual members sending sometimes contradictory signals. To help you make sense of the chatter, here’s an overview of the institution’s most common communications.

FOMC statements

The FOMC meets eight times a year. After each meeting, it issues an announcement that typically addresses U.S. employment and wages, inflation, and the level of overall economic activity. The wording is key:

  • Employment and wages: If job growth is picking up and wages are rising, the labor market is said to be “tightening” and a rate hike might not be far off. However, if there’s “slack” in the labor market—that is, not enough jobs for the people who want them—the Fed might lower rates to stimulate the economy and boost employment and wages.
  • Inflation: When inflation is “quickening,” it’s moving closer to the central bank’s 2% target and rates might rise. When it’s “softening,” it’s falling short of the Fed’s expectations, and a cut might be in the offing.
  • Economic activity: If it’s “picking up,” the FOMC may hike rates to keep the economy from overheating. If overall economic activity is “slowing” or “losing momentum,” however, the FOMC might well cut the federal funds rate.
  • Dissent: Each announcement will note the magnitude of disagreement among FOMC members by referring to the dissenting views of “a few,” “some” or “many.” When only a few members oppose the committee’s decision, it’s unlikely to have an impact on policy. When some or many members disagree, it’s more likely that the decision will be revisited soon.
  • Timing: If a change in the federal funds rate is imminent, the FOMC statement might suggest that a hike is likely “at the next meeting” (as was the case in the Fed’s October 2015 pronouncement, which preceded a rate hike that December). “In the next few meetings” indicates the likelihood of a rate change in the near future, while “in the medium term” suggests a change is farther off.

Summary of Economic Projections

At every other meeting, the FOMC releases its Summary of Economic Projections, or SEP, a detailed projection of U.S. gross domestic product growth, inflation and the path of short-term interest rates over the next three years and beyond. This assessment also includes the so-called dot plot, which shows where each FOMC member thinks the federal funds rate should be at the end of the year, for the next few years and in the longer term (see “Connecting the dots,” below).

The SEP is significant because it provides a window into what the FOMC is thinking. That said, it shouldn’t be interpreted as predictive. According to former Fed Chair Ben S. Bernanke, the dot plot, in particular, is intended to reflect a diversity of views, not a consensus forecast.1 Indeed, the SEP has historically proven to be a poor indicator of future interest-rate policy.

Connecting the dots

The dot plot shows where each Federal Reserve’s Federal Open Market Committee member thinks the federal funds rate should be at the end of the year, for the next few years and in the longer term.

The dot plot shows where each Federal Reserve’s Federal Open Market Committee member thinks the federal funds rate should be at the end of the year, for the next few years and in the longer term.

Source: U.S. Federal Reserve, as of 03/15/2017. Note: Both voting and nonvoting FOMC members can provide forecasts. One member did not submit a longer-run projection for the change in the federal funds rate in conjunction with the March 2017 meeting.

Comments from Fed members

The Fed chair’s role is to guide policy and forge consensus among FOMC members. As a result, Janet Yellen’s views invariably carry the most weight and her public comments can move markets. Other FOMC members frequently express their opinions as well—even when they differ from the majority—which can muddy the outlook on interest-rate policy.

Ignoring the chatter

FOMC members observe a self-imposed communications blackout in the week leading up to a committee meeting in order to avoid creating undue speculation about policy. Unfortunately, the Fed’s silence doesn’t deter the markets or the media from speculating about possible policy moves, generating a great deal of heat but very little light. Better to tune out the noise and focus on your long-term goals—on which the Fed’s near-term policy moves should have little if any impact.

1“Federal Reserve economic projections: What are they good for?” Brookings.edu, 11/28/2016.

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Important Disclosures

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All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

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