On Wednesday afternoon, Federal Reserve Chair Jerome Powell will speak, and markets will respond.
While the central bank is widely expected to deliver its third-straight 75 basis point hike, investors will also be listening closely to any sign of what the Fed might do going forward.
Often, this means keeping your ears peeled for a single changed word or phrase that could signal whether the Fed plans to stay the course or change strategies. The challenge is knowing which words and phrases are important to listen for and how seriously to take them.
This requires a pretty advanced understanding of the Fed, so in the interest of helping readers understand the jargon, here's a quick glossary of common terms that are likely to come up at Wednesday's meeting.
This one is pretty simple. A single basis point is one-hundredth of a percent. So 50 basis points is half of a percent, 75 is three quarters of a percent, etc. When the big rate hike is announced, most news outlets will refer to the number of basis points.
This is the Fed's general term for the goal of keeping inflation under control. It's also one half of what the Fed calls its "dual mandate" which consists of price stability and "maximum employment." While the Fed was more focused on the maximum employment side of the mandate earlier in the pandemic, now it's talking a lot more about price stability.
When the Fed talks about its target range, it's referring to either its target range for the Federal Funds Rate (see below) or its long-term target range for inflation, as compared to the current actual rates. For instance, the Fed's target range for inflation is 2 percent. The current target range for the Federal Funds Rate is 2.25 to 2.5 percent.
Longer-run is just a wonky way of saying long-term, but the St. Louis Fed defines it more precisely as "rates of growth, inflation, and unemployment to which a policymaker expects the economy to converge over time in the absence of further shocks and under appropriate monetary policy." In other words, if all goes according to plan, these are the longer-run goals.
Federal Funds Rate
The Federal Funds Rate is the benchmark interest rate at which banks lend to each other. Contrary to the way it's sometimes spoken about, the Fed can't unilaterally raise or lower interest rates across the economy on a dime. What it does instead is raise or lower the Federal Funds Rate to serve as a guidepost, and then uses monetary policy tools to get real interest rates to match that benchmark rate.
Federal Open Market Committee
The Federal Open Market Committee (FOMC) is the twelve-member committee that is actually responsible for handling monetary policy, which consist of three main tools
- Open market operations
- The discount rate
- Reserve requirements
It would require a seminar to fully explain each of them, but suffice it to say they are three different methods of controlling the flow of money and credit in the economy. For more information on how they work, check out the Fed's own descriptions.
Policy stance is how the Fed refers to its overall orientation toward the economy and encompasses all the tools that the central bank uses to control monetary conditions. Usually, Powell will talk about the Fed's policy stance in a broad way, but sometimes he qualifies it in important ways (see the next entry).
Restrictive or Accommodative
These are two basic descriptors for the Fed's policy stance. If the Fed is taking a restrictive policy stance, that means it's deliberately trying to curb the flow of money and credit into the economy. If it's taking an accommodative stance, that means it's trying to ease or "loosen," to use another common term, the flow of money into the economy.