The minutes of the November FOMC meeting provided further fuel, if needed, to the forecast of a December rate hike…..
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Intesa Sanpaolo – Research Department For professional investors and advisers only
Recent data and speeches, following the 8 November vote, and Yellen’s testimony in Congress, had already been in line with the view that fed funds rates will be hiked at the next meeting, as the market is now pricing with 100% probability.
However, there is growing uncertainty over the future interest rate path, as it will depend on the new Administration’s economic policies and on their estimated effects on the economy and the markets. Rate forecasts will be even harder to formulate in 2017 than in 2016.
– The minutes of the November FOMC meeting confirmed that, even before the presidential elections, the Committee was strongly in favour of a rate hike soon. The assessment of the scenario was generally positive, with risks to the outlook considered as “roughly balanced” by a “substantial majority” of participants, although a few judged that downside risks remained, due to slack on the labour market. “Most participants” expressed the opinion that it could be by all means appropriate to hike rates “relatively soon”, as long as data remain positive and keep outlining an improvement of the economic picture. Furthermore, some participants noted that recent Committee communications were consistent with a rate increase in the near term: therefore, in order to safeguard credibility, it would have been appropriate to move fed funds at the following meeting. Some participants supported the case for a hike at the November meeting, in light of improving data and of the ongoing reduction of slack in the labour market, which could result in overheating. Others, on the other hand, were in favour of allowing the unemployment rate to fall below its equilibrium level to hasten the return of inflation to target, and to curb risks tied to proximity with the zero-rate bound.
– The outcome of the discussion is well-known: the Committee, despite evidence of a further improvement of economic conditions, chose once again to keep rates on hold in November, while signalling that the case for a hike had “continued to strengthen”. The evolution of data and events since then, has made obsolete the vagaries of the debate as reported by the minutes. Data have been strong across the board, and expectations for fiscal expansion in the next two years following the outcome of the 8 November vote make a hike in December virtually guaranteed, as now fully priced in by the market. Yellen, in her hearing before the Joint Economic Committee in Congress on 17 November, reasserted that the economy is making progress, and that the case for a rate hike has continued to strengthen: an increase may come “relatively soon”. Yellen added that fresh evidence available after the November meeting is compatible with the FOMC’s positive outlook. The main information emerged from the hearing consists of post-electoral comments. Yellen said that the Fed, in making its assessments, will take into account the new fiscal policy stance, and could change its scenario based on any new measures, as they are announced. Yellen acknowledged that a fiscal stimulus package could have inflationary consequences: the Fed will consider the potential effects on both inflation and productivity growth. As was expected even before the release of the minutes, the easy decision will be to hike rates in December, whereas it will be harder to build consensus and to signal the new rate path, which will depend on a set of extremely uncertain conditions.
– We expect the Committee to remain cautious for now, and to keep signalling two hikes in 2017, considering that any fresh fiscal stimulus (yet to be defined in terms of size and timing), will have effects at a later stage (late 2017, at best), whereas the tightening of financial conditions (higher yields and strengthening dollar) have immediate effects. However, depending on the degree of fiscal expansion, and on how protectionist US trade policy will become, the FOMC will again face a tough task in building consensus on the path of interest rates over the next two years.
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