FYI | Nov 24 2016
December might be baked in but attention now turns to how Fed policy will respond to Trump’s America.
By Greg Peel
The Fed made its first hike to its funds rate post-GFC in December last year. At that time the committee was anticipating four hikes in 2016. In December last year the US ten-year yield was trading at 2.30%.
The big commodity price plunge and European bank scare of early 2016 conspired to take a March hike off the table. The ten-year had fallen to below 2%. There was much anticipation of a June hike, but that didn’t eventuate either. The yield was then at 1.80%.
Along came Brexit, which saw the yield fall to 1.36% and made a September rate hike touch and go despite ongoing strength in US jobs numbers and signs of inflation finally starting to rise. And so it was, September came and went. But US data continued to improve. If it isn’t going to happen in September, it must surely happen in December, the markets assumed.
The chance of a December hike, as priced by the futures market, rose to over 80% before the US election. The yield had returned to 1.85%. If the data weren’t sufficient on their own, the fact the Fed had talked about rate rises all year and done nothing was enough for most in the market to assume the Fed would simply have to raise in December, or risk losing all credibility.
Then Trump was elected. Trump brought the potential for stronger economic growth fuelled by increased government debt, which in turn suggests rising inflation. Each element on its own is reason for a central bank to raise rates. Not only has the market now moved to assuming a 100% chance of a December hike, the ten-year yield has returned to 2.36%, basically where it was in December 2015.
There was no hike in November, but then no one really expected the Fed to move ahead of the election. The minutes of that meeting were released last night, but given Trump has been elected in the meantime, they were dismissed by Wall Street as being yesterday’s news. Either way, they offered no change to the expectation of a December hike.
For much of 2016 Wall Street feared a Fed rate hike. By the second half the mood turned to one of “please just get it over with”. Now, everyone is well and truly ready for a hike.
So the question is: what happens in 2017?
The US ten-year yield has run from a Brexit low of 1.36% to 2.36%. Yet the Fed is only going to raise by 25 basis points, to (presumably) a range of 0.5%-0.75% from the current 0.25-0.50%. If Wall Street is right, and Trump returns the US to solid, rather than tepid, economic growth, such a low rate seems incongruous by historical measures.
But all along, while pledging a rate rise that is yet to eventuate, the Fed has suggested subsequent policy adjustments will be gradual. Prior to election, the market was pricing in only one hike in 2017 and one in 2018. This is despite the Fed “dots” – projections – suggesting two hikes in 2017 and three in 2018.
Janet Yellen also said, before the election, she wants to allow the US economy to “run hot” for a while, implying the Fed was happy for inflation to pick up. But that was before the election.
The market is now pricing in two hikes in 2017 and two in 2018. This is consistent with the view of the economists at Danske Bank, for one. But Danske also notes, just to cloud the picture further, that the natural rotation of Fed members next year will introduce more known doves to the FOMC than hawks. Under dove Janet Yellen, running hot may mean another year of constant rate rise speculation and constant procrastination from the Fed.
We can only wait and see. Trump is yet to take over the reins. Assuming no resignations from the Fed in the meantime – there has been speculation as to whether Yellen might take her bat and ball and go home given sharp criticism from Trump, pre-election – Fed postings from 2018 will be made by the Trump administration, with Congressional ratification.
We can only shudder at the thought. The Tea Party wants to abolish the Fed and let Congress (politicians) set interest rates.
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