The Federal Open Market Committee (FOMC) holds eight scheduled meetings each year to decide on the interest rate. In this article, we’ll explore how the FOMC decisions affect dollar strength, interest rates, and financial markets.
The Federal Reserve (the Fed) is the United States' central bank. It is responsible for maintaining and growing a stable economy through price stability, controlled interest rates, and maximum employment. The Fed manages monetary policy and the money supply, and its actions influence inflation, consumer behaviour, and a variety of financial products.
The United States Congress established the Federal Reserve on December 23, 1913, to provide America with a safer, more stable, and flexible financial and monetary system.
About the FOMC
The Federal Open Markets Committee (FOMC) is a 12-member organisation directed by a chairperson and comprised of the Board of Governors and a few Reserve Bank presidents.
The Federal Reserve's policy-making body is in charge of determining US monetary policy, including interest rates. FOMC decisions, particularly those involving interest rate adjustments, have a considerable impact on the foreign exchange (FX) market since interest rates affect the value of the US dollar.
FOMC meetings
The FOMC holds eight scheduled meetings each year. At these meetings, the Committee examines economic and financial conditions, decides the appropriate monetary policy stance, and assesses the risks to its long-term objectives of price stability and sustained economic growth.
FOMC meetings are a particularly volatile moment for prop traders since any change in federal funds rates can affect a wide range of economic indicators, including short-term interest rates, foreign exchange rates, long-term interest rates, employment output, and commodity prices.
FOMC decisions impact the Forex market by directly influencing short-term rates, indirectly influencing long-term interest rates, foreign exchange rates, credit supply, investment demand, and economic output.
FOMC meeting minutes
The FOMC meeting minutes, released three weeks after the meeting, offer insight into the committee's thoughts and probable policy measures. If the minutes show a more hawkish or dovish stance than predicted, the USD and other currency values may be further impacted.
Interest rate changes
The Federal Open Market Committee (FOMC) sets the federal funds rate, which banks use to lend reserves overnight. Changes in this rate affect other short-term rates and, indirectly, long-term rates, hence influencing foreign exchange rates.
USD value
Lower interest rates may cause the dollar to fall in value. On the other hand, higher interest rates attract overseas investors, contributing to a stronger US dollar (USD). The global benchmark for measuring the value of the US dollar is the US Dollar Index (DXY). The DXY tracks the performance of the U.S. dollar against a basket of major global currencies. Foreign investors are often attracted when interest rates go up, boosting demand for the US dollar and making it worth more than other currencies. The DXY often gains when the Fed hikes rates.
Investor sentiment
FOMC decisions, meeting statements, and chair's news conference can impact investor sentiment on monetary policy and economic growth. Forex markets may become more volatile as traders adjust their positions in response to these assumptions.
Impact on other currencies
As FOMC decisions affect the value of the USD, they impact the value of other currencies relative to the US dollar. Currencies are relative, so when the dollar appreciates, other currencies essentially depreciate. It also makes countries that have dollar-denominated debt less creditworthy, as it makes it harder for them to purchase the U.S. currency to manage their debts.
Impact on businesses
A stronger dollar makes imported goods cheaper in the US. Foreign companies and investors with US business, as well as multinational corporations earning dollar income, benefit from this.
Conversely, when the US dollar depreciates, American consumers' cost of imported goods rises. US exports become more competitive globally, potentially boosting those sectors of the economy. However, foreign investment may decline as dollar-denominated assets lose relative value, and inflationary pressures could increase due to higher import costs.
Closing notes
FOMC decisions, particularly those involving interest rate increases, have a direct and considerable impact on the value of the US dollar, which in turn influences the entire forex market and exchange rates between other currencies and the dollar.
Now that you’ve learned how the FOMC affects financial markets, particularly the USD, you may be looking for resources to help you monitor such changes in a practical trading setup. The Currency Strength Tool offered on the OANDA Labs website comes in handy, enabling traders to track currency strengths.
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