Investors sanguine over possible Fed hike

US stock indices surged yesterday to close out at fresh record highs. The moves followed Donald Trump’s speech to Congress which was regarded as his most conciliatory and unifying since his victory speech back in early November. It was also considered to be his most presidential as it was optimistic in tone, addressed the Trump administration’s plans for America’s future while there were no snipes at either the media or the previous presidency. The speech was light on detail, but investors felt that its tone should help the administration push much of their plans through Congress.

Now attention turns once again to the Fed and US monetary policy. Ahead of Trump’s speech William Dudley, New York Federal Reserve President and vice-chair of the FOMC, said that the case for tightening "has become a lot more compelling." Mr Dudley is considered to be one of the more dovish members of the FOMC and his comments led to a rapid recalculation of the odds on a rate hike at the next FOMC meeting in less than two weeks’ time. The CME’s FedWatch tool nearly doubled to 68% yesterday while the Bloomberg calculation of a 25 basis point rate hike this month is now around 80%. Since the financial crisis any prospect of higher rates has typically spooked equity markets. However, the situation is quite different these days. Equities are soaring as a rate rise now comes for all the right reasons. The US economy is improving, the Fed is seen as getting ahead of the curve (at least where inflation is concerned) and investors can now look forward to fiscal stimulus and a business-friendly Trump administration. What could possibly go wrong?