BofA Securities published a primer on June 14 that sets out the basic elements investors and analysts use to track the Federal Reserve’s policy direction. The note covers the Fed’s mandate, the way policy decisions are made, the communication tools and projections that shape expectations, and the composition of the central bank’s balance sheet.
Mandate and the trade-offs
The Fed operates under a dual mandate of maximum employment and stable prices. BofA notes that price stability is operationalized as a 2% inflation objective measured by the personal consumption expenditures index. The bank reiterates the standard policy trade-off: rate increases tend to reduce inflation but put upward pressure on unemployment in the short run, with those trade-offs becoming especially acute during supply shocks.
FOMC voting dynamics
Federal Open Market Committee decisions are taken by majority vote, BofA says, with up to 12 voting members and decisions typically requiring seven votes to pass. In this year’s lineup of voting regional Federal Reserve presidents, BofA identifies Hammack of Cleveland, Logan of Dallas, Kashkari of Minneapolis and Paulson of Philadelphia as leaning hawkish.
June meeting and outlook
The Fed left its policy rate unchanged at 3.75% at its June meeting. BofA highlights that a majority of FOMC members at that meeting expressed a hawkish inclination, viewing at least one interest-rate increase as likely before year-end. That meeting was also the first under the authority of new Fed Chair Kevin Warsh, who presented a substantial overhaul of the central bank’s communications and economic projections.
Frameworks for assessing policy
BofA describes several analytical frameworks it uses to assess the Fed’s policy stance: Taylor Rule-style policy prescriptions, financial conditions indexes, measures of output and unemployment gaps, and estimates of the natural rate of interest (r-star). The bank’s current risk assessment indicates upside risks for both inflation and unemployment.
Market indicators and preferred measures
For tracking market expectations of policy, BofA prefers FOMC overnight index swaps (OIS) to fed funds futures and SOFR futures, calling OIS the cleanest read of rate expectations while noting that all three instruments should provide broadly similar signals.
Balance sheet snapshot
BofA reports the Fed’s balance sheet at $6.7 trillion, equivalent to about 21% of nominal GDP. The bank says the asset side is dominated by Treasuries and agency mortgage-backed securities, while liabilities are led by bank reserves, currency in circulation and the Treasury’s cash balance.
Key points
- The Fed’s dual mandate emphasizes both maximum employment and a 2% PCE inflation target.
- FOMC policy is set by majority vote from up to 12 members; several regional presidents are currently described by BofA as hawkish.
- BofA favours OIS as the cleanest market proxy for rate expectations and highlights a $6.7 trillion Fed balance sheet composed mainly of Treasuries and agency MBS.
Impacted sectors
- Bond markets and interest-rate sensitive credit markets, which use rate expectations to price instruments.
- Banking and reserves-related activity, given the liability composition of the Fed’s balance sheet.
- Labour markets and consumer-facing sectors affected by inflation and unemployment dynamics.
Risks and uncertainties
- BofA’s assessment points to upside risks for inflation and for unemployment, introducing uncertainty for monetary policy and markets.
- Majority hawkish leanings among FOMC members raise the prospect of at least one rate increase before year-end, per the June meeting’s indications.
- Supply shocks complicate the trade-off between lowering inflation and supporting employment, heightening policy uncertainty.
This primer is presented as an explanatory guide to the variables and tools market participants monitor when forming expectations about the Fed’s path; it consolidates the bank’s chosen frameworks and the balance-sheet facts that feed into that analysis.