Fed takes more hawkish turn, but all depends on 'Trumponomics'
Yesterday’s rate hike by the US Federal Reserve was entirely expected by the markets, but the monetary policymakers did signal that their action would take a more hawkish tone from now on, according to economists and strategists.
But whether the 12 members of the reserve’s Federal Open Market Committee (FOMC) will be able to carry out their intended normalisation of monetary policy all depends on how the economic policies of Donald Trump materialise once his term as US president begins next year, many agreed.
Richard Clarida, global strategic adviser at PIMCO, said: “While the Fed did hike its target for the federal funds rate to a range of 0.5% to 0.75%, the real message was delivered by the ‘dot plot,’ which moved unmistakably in the hawkish direction for 2017.
The dot plot is part of the FOMC’s summary of economic projections and shows how each meeting participant thinks the fed funds rate should develop.
Four FOMC members seemed willing to place at least a modest bet that “Trumponomics” would justify three hikes instead of two in 2017, he said.
Nick Gartside, international CIO for fixed income at JP Morgan Asset Management, said the Fed’s rate increase was a welcome move to policy normalisation.
“Perhaps more importantly, the Fed also acknowledged the new reality of fiscal policy in the driving seat by edging up its positive assessment of the labour market and the economy,” he said.
He predicted the market would price in at least four rate hikes for next year – from currently expecting two hikes – and a 10-year US Treasury yield of 3.5% by the end of next year.
Neil Williams, group chief economist at Hermes Investment Management, said the move yesterday confirmed the Fed would remain the test case for whether any central bank could normalise rates.
“We expect it to try, but fail, with the funds target peaking out in 2017 at just 1% – way lower than the near 3% in the Fed’s own ‘dot plot’ rate assumptions,” he said.
Loose fiscal policy will come on top of – not instead of – a loose monetary stance, he said.
“First, it could be a year of two halves,” Williams said. “The likely short-term growth stimulus from Mr Trump’s sizeable fiscal expansion could then be muted by the threat of widespread protectionist policies – at first locally, then spreading internationally.”
Rick Rieder, CIO of fundamental fixed income at BlackRock and co-manager of fixed income global opportunities, said the quarter-point rate hike, although priced in, reflected a broader global policy evolution, and that there was a modestly hawkish tilt to Committee member rate projections for the years ahead.
“Overall, the hallmarks of this new policy and market regime are clearly reflation, inflation and greater optimism that a more productive balance between growing fiscal and receding monetary policy stimulus can be found,” he said.
Thanos Bardas, head of interest rates and sovereigns, global investment-grade fixed income, at Neuberger Berman, described the rate increase as a “happy hike”, coming as it did against the backdrop of strong economic data and record market highs – as opposed to the rate hike in 2015, when the background was “grim”.
“The Fed is pleased about economic progress, the potential for rate normalisation and a narrowing of its expectations gap with the market,” he said.
Bardas said that, despite the modest acceleration in pacing, the Fed was likely to take a gradual approach over the next few quarters.
“There’s been a lot of talk about fiscal stimulus – which some board members took into account in raising rate expectations – but nothing has actually happened yet, and resulting growth could be more stingy than investors expect,” he said.
Ken Taubes, head of US investment management at Pioneer Investments, said he found it interesting that FOMC economic projections did not reflect any big changes from their September levels – apart from one extra rate hike in 2017.
“The projections were largely unchanged despite the dramatic post-Trump election rally in equity markets, and sharp increases in Treasury yields, inflation expectations and the US dollar,” he said.
“While the Fed will not change its forecast until it sees the impact of Trump’s policies, there is a high likelihood that Trump’s policies will deliver stronger economic growth, accompanied by higher inflation and, potentially, higher deficits.”
Larry Hatheway, GAM chief economist and head of GAM Investment Solutions, agreed the overall message from the Fed was more hawkish than expected but found it notable that its official statement had not mentioned the widely expected US fiscal expansion or economic deregulation.
“As a consequence, should those factors materialise, the Fed may have to further lift its assessments for US growth, inflation and the likely path of interest rates,” he said.