The Federal Reserve is the most important central bank in the world because of the special role the US dollar plays as a reserve currency. Therefore, traders always pay close attention to the bank’s meetings and activities. The Federal Open Market Committee (FOMC) is one of the most important items in the economic calendar.
In this report, we will look at what the FOMC is and why it should matter to you as a trader.
What is the FOMC?
The Federal Reserve was created in 1913 to help regulate the financial sector. Before its creation, many banks in the US were going out of business, putting the livelihoods and savings of millions of people at risk.
Today, the bank helps to set the country’s monetary policy, helps to promote the stability of the financial sector, and promotes the strength of the banking sector. The Fed has three key entities:
- Board of Governors
- the Federal Reserve banks
The FOMC is a special committee of the Fed that is chaired by the Fed governor. Its role is to analyse the economy and conduct the necessary monetary policy. It does this in its scheduled – and often impromptu – meetings.
How often is the Federal Open Market Committee meeting? The Calendar
The scheduled meetings are held every month, without a specific frequency. You can easily find the calendar and the archive (complete with PDF) on the FED website.
The next will be on:
- September 15-16*
- November 4-5
- December 15-16*
* Meeting associated with a Summary of Economic Projections.
You can watch them live in the FED Live Broadcast.
Key tools in the FOMC toolbox
The FOMC has several tools in its tool box that it deploys to ensure the stability of the market. Interest rates are among the most useful tools in the toolbox. Ideally, the Fed lowers interest rates when the economy is going through a challenging period. The goal is to incentivise people to move their funds from savings to investments and to promote consumption.
Another goal is to make it cheaper for people to access capital.
Quantitative easing is another tool. This is where the Fed creates money from thin air and buys assets like exchange traded funds (ETFs) and government bonds. The goal of QE is to ensure that there is enough liquidity in the market.
Other tools that the FOMC has is to create money and lend directly to companies.
How the FOMC meeting decision affect trading
The FOMC decision is usually one of the most important items in the economic calendar. However, its relevance as a trading tool has been falling in recent years because of something known as forward guidance.
In the past, major assets like currencies, stocks, and bonds used to move rapidly in reaction to monetary policy. That is because traders used to be in the dark about what the Fed would do during the meeting.
To reduce this volatility, the Fed adapted something known as forward guidance. This is where the FOMC meeting outlines what it will do in the future meetings. For example, during the coronavirus pandemic, the bank has reduced interest rates to zero and guided that rates will remain that low for the next few years.
Something more about day trading volatility you could find useful:
- How to Maximizing Returns when Trading it
- How to Trade in Periods of High Volatility
- The CBOE Volatility Index
What assets still react?
Still, several assets tend to react to the FOMC decision. First, the US dollar tends to fall if the statement of the FOMC is dovish in nature. On the other hand, if the Fed’s statement is hawkish, the dollar tends to climb.
Second, stocks rise if the Fed sounds dovish because companies prefer low interest rates. The same is true with corporate bonds.
How to prepare for the FOMC decision
There are several things you need to do to prepare for the FOMC decision. First, you need to know when the meeting will happen. You can know this by checking out the economic calendar that is provided for free in most trading websites.
Second, you need to check the Fed Rate Monitor Tool, which shows you what analysts are expecting in the current and next rate decision.
Finally, you need to read reports in credible platforms like Bloomberg, Financial Times, and Wall Street Journal on the meeting. In other words, you have to inform yourself properly.
The FOMC decision is among the most important events in the economic calendar. Important because of how it influences the market in the long run. Indeed, the ongoing rally in stocks and decline of the dollar index has been edited to the actions by the Fed.
Therefore, as a trader, you need to follow the strategies above to trade the FOMC.
External useful Resources
- Federal Open Market Committee (FOMC) Definition – Investopedia