FED: one rise 2016, but how many for 2017?

In line with the fully priced-in market consensus, the Federal Reserve has raised its Fed Funds target range by 25 bps to 0.50-0.75%. Whereas in December 2015 the median scenario, and ours, was for four rate rises in 2016, this December rise has been the only one this year and it took until the market had actually priced-in a high probability of a rate rise before the Federal Reserve took action.

The Fed also published the FOMC’s economic outlook, and although largely unchanged, it did point to slightly tighter monetary policy expectations with the median forecast now set at three rate hikes for 2017, one more than had been expected.

During the press conference, Fed chair Janet Yellen underlined the fact the Federal Reserve, in looking to improve the economy’s growth potential, did not want it to overheat1. Furthermore the central bank also questioned the suitability of any fiscal stimulus plan in an environment approaching full employment.

OUR ANALYSIS

The markets’ reaction shows that the Fed’s comments were more “hawkish”2 than had been expected: the dollar moved from 1.06 to 1.04 against the euro, and two-year yields rose 10 basis points between Tuesday and Thursday to reach 1.27%, a record high since 2009. The reaction also shows that the markets are more in line with the Fed’s scenario than expectations expressed in September 2016 (see graph). Whilst the Fed’s caution during 2016 was no doubt based on a desire to avoid upset, the markets’ changed attitude should comfort the Fed in its decision to now “normalise” monetary policy.

The risk with this scenario is a faster pace of rate hikes than anticipated by the markets. Aside from any potential fiscal stimulus, latest economic indicators (PMI, NAHB HMI) bode well for economic growth and should result in an unemployment rate below the Fed’s end-of-2017 expectation of 4.5%. The pace of wage increases should consequently also pick up. However, although the rise in the dollar is currently moderate when compared to 2014-2015 levels, any excessive rise in the greenback could make the Fed more cautious, as could any periods of financial instability.

1 The underlying idea is to maintain an accommodative policy to secure higher-than-potential growth and push the economy into both re-integrating the long-term unemployed, as well as influencing economic forecasts and investment spending. This demand-led policy should improve the economy’s supply-side. For more information, see Janet Yellen, Macroeconomic Research after the crisis, 14 October 2016.

2 Hawk: favours tight monetary Policy.

The opinion expressed above is dated December 19th, 2016 and is liable to change.

 

 

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Julien-Pierre Nouen

Directeur des études économiques et de la gestion diversifiée