18.12 Weekly Viewpoint : After one year, the Federal Reserve has hiked rates again

After one year, the Federal Reserve has hiked rates again, signalling that next year it may do so again three on three occasions instead of two. This time, the markets seem to believe the Fed, helped by expectations for aggressive federal tax cuts next year….

Sign up for our free newsletter to receive weekly news from BONDWorld. Click here to register for your free copy 

Intesa Sanpaolo – Research Department For professional investors and advisers only

The FOMC meeting came to an end with the expected 25bp rate hike, voted unanimously. The statement and macroeconomic projections signal improved confidence in the strength of the recovery and in the achievement of the full-employment and 2% inflation goals. Although Yellen maintained a cautious stance, the overall message was more hawkish than expected.

The main change introduced by the meeting is the upward shift of the estimated median in 2017 (implying that the median forecast is now for three rate hikes in the year) and, marginally, of the long-term interest rate as well (from 2.9% to 3%). During her press conference, Yellen stressed that such marginal movements in terms of size and scope should not be given too much weight. In both the statement and the press conference the Fed reasserted that the hikes will be gradual and dependent on the evolution of the scenario.

However, the sign of the derivative is an important indicator of the change in regime, after years in which the point of arrival of interest rates pushed down.

This reflects a much brighter assessment of the labour market, which emerges from both the statement and the macroeconomic projections. Risks are still considered as being “broadly balanced”, but downside risk factors of international origin are no longer singled out. Monthly data have resulted in an upward revision of forecast growth in 2016 (to 1.9% from 1.8%) and in 2017 (to 2.1% from 2%). According to the FOMC, GDP growth should stay at levels above potential (1.8%) throughout the forecasting horizon. For the unemployment rate the projection is 4.7% in 4Q 2016 (from 4.8%), and most importantly, a stabilisation at 4.5% is expected in the next three years, three tenths below the equilibrium rate, still estimated at 4.8%. As regards the deflator, the only change concerns 2016 (1.5% from 1.3% y/y in 4Q), whereas the 2% goal is still forecast to be achieved starting in 2018, for both the overall index and the underlying index.

These changes compared to the September picture were made even without openly taking into account potential fiscal stimulus, still too uncertain at present in terms of timing, modalities and size to be incorporated into the scenario. According to Yellen, some FOMC participants, but not all of them, have already incorporated “some assumption of a change in fiscal policy into their projections”. Plans to cut taxes and step up federal spending may have effects on growth and inflation, although there is “time to wait to see what changes occur”.

However, the Fed Chair said that fiscal stimulus “is not obviously needed” to achieve full employment, which has already been reached thanks to monetary policy.

In conclusion, the December meeting certifies the change in regime under way in the US economy: growth is more solid and risks could be skewed to the upside in 2017, once the new administration’s fiscal policy guidelines will have been disclosed.

The Fed will remain cautious in hiking rates for two reasons:

1) the strengthening of the dollar and the rise in long-term yields will already make financial conditions tighter;

2) fiscal stimulus is still uncertain and should start to have significant effects mostly starting in 2018. If, as is likely to be the case, a well-defined fiscal policy plan will not be announced before 2Q, for the time being we may assume that rates will be left unchanged in 1Q, and that the next hike will come in the spring. However, the markets have now resumed heeding the central bank’s guidance: two hikes are fully priced in, a third at least in part.

Analyst Certification

The financial analysts who prepared this report, and whose names and roles appear on the first page, certify that: (1) The views expressed on companies mentioned herein accurately reflect independent, fair and balanced personal views; (2) No direct or indirect compensation has been or will be received in exchange for any views expressed. Specific disclosures: The analysts who prepared this report do not receive bonuses, salaries, or any other form of compensation that is based upon specific investment banking transactions.

Important Disclosures
This research has been prepared by Intesa Sanpaolo S.p.A. and distributed by Banca IMI S.p.A. Milan, Banca IMI SpA-London Branch (a member of the London Stock Exchange) and Banca IMI Securities Corp (a member of the NYSE and NASD). Intesa Sanpaolo S.p.A. accepts full responsibility for the contents of this report. Please also note that Intesa Sanpaolo S.p.A. reserves the right to issue this document to its own clients. Banca IMI S.p.A. and Intesa Sanpaolo S.p.A. are both part of the Gruppo Intesa Sanpaolo. Intesa Sanpaolo S.p.A. and Banca IMI S.p.A. are both authorised by the Banca d’Italia, are both regulated by the Financial Services Authority in the conduct of designated investment business in the UK and by the SEC for the conduct of US business.
Opinions and estimates in this research are as at the date of this material and are subject to change without notice to the recipient. Information and opinions have been obtained from sources believed to be reliable, but no representation or warranty is made as to their accuracy or correctness. Past performance is not a guarantee of future results. The investments and strategies discussed in this research may not be suitable for all investors. If you are in any doubt you should consult your investment advisor.
This report has been prepared solely for information purposes and is not intended as an offer or solicitation with respect to the purchase or sale of any financial products. It should not be regarded as a substitute for the exercise of the recipient’s own judgement.
No Intesa Sanpaolo S.p.A. or Banca IMI S.p.A. entities accept any liability whatsoever for any direct, consequential or indirect loss arising from any use of material contained in this report.
This document may only be reproduced or published together with the name of Intesa Sanpaolo S.p.A. and Banca IMI S.p.A.. Intesa Sanpaolo S.p.A. and Banca IMI S.p.A. have in place a Joint Conflicts Management Policy for managing effectively the conflicts of interest which might affect the impartiality of all investment research which is held out, or where it is reasonable for the user to rely on the research, as being an impartial assessment of the value or prospects of its subject matter. A copy of this Policy is available to the recipient of this research upon making a written request to the Compliance Officer, Intesa Sanpaolo S.p.A., 90 Queen Street, London EC4N 1SA.
Intesa Sanpaolo S.p.A. has formalised a set of principles and procedures for dealing with conflicts of interest (“Research Policy”). The Research Policy is clearly explained in the relevant section of Banca IMI’s web site (www.bancaimi.com).
Member companies of the Intesa Sanpaolo Group, or their directors and/or representatives and/or employees and/or members of their households, may have a long or short position in any securities mentioned at any time, and may make a purchase and/or sale, or offer to make a purchase and/or sale, of any of the securities from time to time in the open market or otherwise. Intesa Sanpaolo S.p.A. issues and circulates research to Qualified Institutional Investors in the USA only through Banca IMI Securities Corp., 245 Park Avenue, 35th floor, 10167 New York, NY,USA, Tel: (1) 212 326 1230. Residents in Italy: This document is intended for distribution only to professional investors as defined in art.31, Consob Regulation no. 11522 of 1.07.1998 either as a printed document and/or in electronic form. Person and residents in the UK: This document is not for distribution in the United Kingdom to persons who would be defined as private customers under rules of the FSA.
US persons: This document is intended for distribution in the United States only to Qualified Institutional Investors as defined in Rule 144a of the Securities Act of 1933. US Customers wishing to effect a transaction should do so only by contacting a representative at Banca IMI Securities Corp. in the US (see contact details above).

Valuation Methodology

Trading Ideas are based on the market’s expectations, investors’ positioning and technical, quantitative or qualitative aspects. They take into account the key macro and market events and to what extent they have already been discounted in yields and/or market spreads. They are also based on events which are expected to affect the market trend in terms of yields and/or spreads in the short-medium term. The Trading Ideas may refer to both cash and derivative instruments and indicate a precise target or yield range or a yield spread between different market curves or different maturities on the same curve. The relative valuations may be in terms of yield, asset swap spreads or benchmark spreads.

Coverage Policy And Frequency Of Research Reports

Intesa Sanpaolo S.p.A. trading ideas are made in both a very short time horizon (the current day or subsequent days) or in a horizon ranging from one week to three months, in conjunction with any exceptional event that affects the issuer’s operations. In the case of a short note, we advise investors to refer to the most recent report published by Intesa Sanpaolo S.p.A’s Research Department for a full analysis of valuation methodology, earnings assumptions and risks. Research is available on IMI’s web site (www.bancaimi.com) or by contacting your sales representative.

Source: BONDWorld.ch