You have probably heard of the FOMC and how the crypto space gets jittery when this acronym is mentioned. The Federal Open Market Committee (FOMC) is the Fed’s arm for monetary policy-making. Whatever this powerful says affects not just the digital assets space, but also the traditional market. But what exactly is it? And why does every decision it makes affect everything related to finance? Let us find out together.
The Federal Reserve System, often referred to as the Fed, was established in 1913 by the Federal Reserve Act. Its job is to ensure the stability of the US banking system. On the other hand, the Federal Open Market Committee (FOMC) was created by an amendment to the Banking Act of 1935. It is the main policy-making body of the Fed that handles the national monetary policy.
The FOMC is composed of 12 voting members – seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York, and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. There are also several nonvoting members who participate in the meetings and discussions, such as other Reserve Bank presidents and staff members.
The Committee holds eight regularly scheduled meetings per year or about every six weeks. These meetings tackle the economic conditions and determine the appropriate monetary response.
Why Should Investors Care About the FOMC?
The question above can be answered with a couple of words: interest rates.
Why? Let us expound on the answer.
- The FOMC sets the interest fund rates. In a nutshell, this affects the country’s interest rates and other economic activities.
- Higher interest rates make borrowing more expensive and reduce money circulating in the economy. The less money circulating, the lesser the money for investments and business activities.
- A rate hike is one of the tools used to cool down inflation.
- However, higher interest rates can also strengthen the US dollar. Higher interest rates will attract foreign investors to invest in US assets. But this can also make US exports more expensive and less competitive in the global market. In short, export companies will suffer.
- The change in rates can make US treasury bonds more attractive. On the other hand, it will make riskier and more volatile assets like stocks and crypto less appealing.
Why Should Crypto Investors Care About the FOMC?
Analysts and investors have been looking at the correlation between the traditional stock market and crypto for a long time. More specifically the correlation between Bitcoin (BTC) and the S&P 500 (SPX). Anything that happens in the traditional market has a high probability of being replicated in the digital assets space.
Let us look at the next two charts:
These charts highlight the week in which the FOMC last decided to raise interest rates by 25 basis points to 5.25-5.5%. It happened in July of this year. The prices of both Bitcoin and SPX dropped several days after the announcement.
You may be wondering why they did not drop right away. There is a theory that explains this. The delayed effect is because the new interest rates only affect new borrowers. Those currently locked on a long-term fixed rate are not affected. So it will take some time before the effects hit the market.
Remember, higher rates mean less money for investments, especially for riskier assets. Investors would rather park their money on more stable assets like bonds. Crypto is riskier and more volatile than traditional investment instruments.
- FOMC is a policy-making body under the Fed. Its job is to review market conditions and set targets for interest rates. Rate hikes are used to control inflation.
- Higher interest rates are seen as bad for stocks and crypto because they limit the money supply in the economy. Less money circulating means less money for businesses and risky investment instruments like stocks and cryptocurrencies.
- On the opposite side, lower interest rates will increase the money supply which will bring fresh capital to the market.
The FOMC needs to do a balancing act in order to control inflation and support the economy at the same time. We all want lower inflation, but we also want our financial assets to grow. Unfortunately, these two things are usually on opposite sides.
An ordinary retail investor cannot change nor influence the FOMC’s decision, but it is prudent to be informed at all times. This way, appropriate risk management can be applied.