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A Beginners Guide to Fed Watching

US overnight interest rates are set by the Board of Governors of the Federal Reserve System. They generally set a Target Range of 25bps and meet about eight times a year for two days to debate the state of the US economy and whether the rate should be changed. The Board consists of twelve members; seven governors including the Chair, currently Janet Yellen, the president of the New York Fed and the remaining four members from the presidents of the other eleven feds who are grouped into regions¹ and annually rotate their membership within their regional group. The official goal of the FRS is to "promote maximum employment, stable prices, and moderate long-term interest rates" and their basic challenge is to keep interest rates low to promote the economy without creating an inflationary bubble which may require much higher rates to control and then risks creating a recession in the process. The problem is that a change in interest rates may take many months to directly affect the economy although expectations of rate changes can affect markets and business confidence much more quickly. This tends to make senior Fed officials very careful with their words, Janet Yellen is a master of this.

The actual FOMC meeting attendance is huge, all the fed presidents plus their economists and statisticians turn up. There is usually a press conference in the afternoon to announce any change in the target interest rate but the minutes indicating who voted which way are not released for a few more weeks. In recent years the Fed has tried to operate within a broad consensus and where it can prepare markets so that there are few surprises. (This was not always the case.) To get a good perspective on what the Fed might do I recommend;

1. Get familiar with the relative economic standpoint of the voting members, they are broadly grouped into Hawks who favour raising rates sooner and Doves who are more cautious about raising rates prematurely and slowing the economy unnecessarily. The 2017 Committee is below² with my take on the Hawk/Dove balance. The trigger for me is when one hears a hawk or a dove make a statement that is out of line with their previous position. The press is full of their comments and also those of other Fed presidents but I think it those with the vote that matter. Also, hearing that say a Hawk thinks rates need to rise isn't really adding anything new to the debate.

2. Follow the key economic stats, America being a vast sophisticated economy publishes a good 10-12 statistical measures each week. But some may be lagging indicators (like credit defaults) while others may be leading indicators, (like housing starts). Also, they all have reliability issues, and it may be worth being aware if a stat is often restated as it weakens its influence on the policy setters. Generally the monthly Non Farm Payrolls which comes out on the first Friday of each month for the previous month is seen as the most important, but it has to be balanced with unemployment claims and labour force participation statistics.

3. If all this sounds too labour intensive then there is a very clear summary of the market's view of the above provided by CME. CME have a large liquid market in futures on the actual Fed Funds rate, and the profile of this market's prices can be analysed to determine the market probability of the rate at each of the upcoming FOMC meetings. Their analysis is here.

Here's an example of how it fits together in practice for the rate rise in March 2017;

Date	Event	CME Fed Funds Market range predictions	Comment
9 February	CME FF market is predicting that the March FOMC will keep rates in the existing range of 50-75.	50-75 91% 75-100 9%	Solid consensus that there will be no rise.
During February	A variety of fairly positive stats were published and the markets began to wonder if a March rise is more probable.	50-75 65% 75-100 35%	Some indications that the rate would rise
1 March	Lael Brainard (dove) spoke in Massachusetts “Assuming continued progress, it will likely be appropriate soon to remove additional accommodation, continuing on a gradual path".	50-75 34% 75-100 66%	A dove indicated rates should rise soon moved the probability by 31 percentage points.
2 March	Jerome Powell (a marginal dove) also spoke in favour of a rise. There were also comments a few days later by William Dudley and President Yellen herself reinforcing the change.	50-75 22% 75-100 78%	Another rate supportive comment pushed the probability even higher.
10 March	February Non Farm Payrolls were published with an 235,000 increase well above the market's anticipated 190,000 clearly avoiding any question that the economy was not growing consistently. The rate change was then announced on 15 March.	50-75 11% 75-100 89%	The market now sees a hike as a near certainty

What I like about this chronology is the clear impact the change in the doves' position has. If you read press comments on previous speeches by Ms Brainard you will see that her views were much more cautious about the evidence that the economy was in danger of overheating. The other impressive feature of this is how the policy setters changed the market's consensus on a March rise in no more than a month with the least possible impact on equity, FX and long dated bond yields.

There is another item a dedicated Fed Watcher studies, this is the "Dot-Plot" which shows when each FOMC member expects rates to rise. This is the data that drives press comments where they indicate that the Fed expects three or four rises in a particular year. CME also help us keep track of this, I would caution that it's a forecast, not a plan and it seems that each Fed decision is driven by the debate and evidence available at that time.

¹The US Feds Regional Groups

Boston, Philadelphia, Richmond

Cleveland, Chicago

Atlanta, St. Louis, Dallas

Minneapolis, Kansas City, San Francisco

²2017 FOMC

Janet L Yellen, Board of Governors, Chair Dove

William C Dudley, New York, Vice Chair Dove

Lael Brainard, Board of Governors Dove+

Charles L Evans, Chicago President and CEO Dove+

Stanley Fischer, Board of Governors Hawk-

Patrick Harker, Philadelphia President and CEO Hawk

Robert S Kaplan, Dallas President and CEO Dove-

Neel Kashkari, Minneapolis President and CEO Dove

Jerome H Powell, Board of Governors Dove-

Daniel K Tarullo, Board of Governors Dove+

Remaining 2017 FOMC Meetings

25-26 July

19-20 September

31-1 October/November

12-13 December

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