Question

Read the latest FOMC statement (December 19, 2018) and explain the decision about the federal funds rate. What are the expectations about future changes in the federal funds rate? What was the reaction of the stock market immediately after the press release?

Answer 1

The federal funds rate is the rate at which banks , credit institutions lend to other banks and credit institutions overnight.In the financial market, federal funds rate is a benchmark. The federal reserve on wednesday(December 19) raised interest rate for the 4th time this year.The Fed increased the interest rate by 25 basis point to a new band of 2.25%-2.5%. All the 10 members of FOMC were in favor of the raise.This was the highest rate of the Fed since 2008.

The expectations are that there may be a couple of hikes in 2019.The policy makers are happy about the steady route of rate hike.The policy makers feel that inflation is low and they can still wait for sometime before the hike.However policy makers also feel that low inflation can mean low economic demand.It may also reflect a labor market which is working below the potential level.

Stock prices are effected by federal funds rate changes.Certain sectors like utilities,finance, telecommunication ,basic material respond more to this federal funds rate changes. The direct connection between federal funds rate changes and costs and revenues of the financial sector , is responsible for the financial sector to be more responsive to changes in funds rate.