Daily Insight – Trump’s influence on the Fed: higher rates ahead

by: Maritza Cabezas , Georgette Boele

FOMC raises the target range for the federal funds rate

With a unanimous vote, FOMC policymakers rose the target range for the federal funds rate to 0.50-0.75% after a year. This rate hike, which was widely expected, comes at a time when the US economy has been improving. The statement following the FOMC meeting was hawkish in tone. The Committee expects that economic conditions will evolve in a manner that will warrant a slightly more aggressive pace of rate hikes than markets expected. Three rate hikes in 2017, compared to two forecasted in the September meeting. This is in line with our base scenario for 2017, which includes three Fed rate hikes. The Fed has a slightly more aggressive path in 2018, with three rate hikes, while we only forecast two. The pace of rate hikes remains gradual. The neutral rate is still below historical standards.

Global-Daily-Insight-15-December-2016.pdf (151 KB)

FOMC statement: improvement in labour market will be more modest ahead

The Fed mentioned in the statement that monetary policy supports “some further strengthening in labor market conditions and a return to 2 percent inflation”. Compared to the previous language used, this suggests that FOMC members do not see much more room for improvement in the labour market ahead. Moreover, the inflation outlook is viewed with more caution. The statement mentioned that market based inflation expectations have moved up considerably. The stimulus plans from President-elect Donald Trump would give an additional boost to the economy, but they have already impacted market-based inflation expectations.

FOMC forecasts: projections have not changed much

Economic forecasts barely changed from the September FOMC meeting. There was a minor upward change in GDP growth forecasts in 2016 and 2017. The median forecast is now 1.9% and 2.1%, respectively. Meanwhile, unemployment was a touch lower and is 4.7% in 2016 and 4.5% in 2017, not far from the long-term rate of 4.8%. The median core inflation projection was unchanged in the forecast period, reaching the inflation target of 2% in 2018.

View on Trump’s policies

Chair Yellen in her press conference, highlighted the independence of the Fed and did not comment in particular on Trump’s stimulus policies. However, in general, she mentioned that stimulus would be more favourable if it supported improvement in productivity growth. She added that the Fed is operating under a “cloud of uncertainty”, regarding possible policy changes and their potential economic effects as a new president and new Congress prepare to take office. Those changes will have to be factored into the Fed’s decisions and outlook, she said, once they take definite shape. She did mention that she clearly feels that the US financial regulatory approach does not need a significant overhaul. This is in response to president-elect Trump’s proposals to dismantle Dodd Frank regulation.

Market reactions

The more hawkish than expected statement has resulted in a higher US dollar. US Treasury yields also moved higher, with both 2yr and 10yr US Treasury yields rising at the same pace. Initially, US equity markets were very resilient. However, later on they moved lower. Gold prices fell reflecting the negative combination of higher US dollar and higher US Treasury yields. We expect the rally in the US dollar to continue next year and EUR/USD to break through the parity level.