Fed: Interest rate hike in December unless you play Trumps - Natixis

Research Team at Natixis, notes that unsurprisingly, the Federal Reserve decided to maintain the target range for the Fed Funds rate when the FOMC met on 1 and 2 November and even so, it did not forget to validate the market’s expectations of an interest rate hike at the December meeting.

Key Quotes

“Few changes as regards the description of the economic environment and outlook

The first paragraph, devoted to a description of the economic environment, was largely unchanged. Consistent with the publication of Q3 2016 GDP (+2.9% quarter-on-quarter on an annualised basis vs. +1.4% in Q2 and +0.8% in Q1), the Committee noted that economic activity has picked up from the modest pace seen in the first half. Job gains are described as solid. The one negative is that the Committee talked of a moderate rise in household spending (when in the previous statement it talked of a strong rise).

What is new is that the statement is a little more hawkish as regards inflation

Compared with the statement issued in September, the Committee made three changes in its description of inflation:

- “Inflation has increased somewhat”, when previously “inflation has continue to run below the Committee’s 2% long-run objective”;

- Market-based measures of inflation have moved up;

- Inflation is no longer expected to remain weak given the upturn in energy prices.

The Federal Reserve therefore recognised that the inflation risk was undergoing a gradual reversal, and was now tilted on the upside.

No indication as to the timing but a relatively clear signal nonetheless

At the same time, the Committee decided against the calendar reference it used in October 2015 to prep the market for the December 2015 hike. However, it did say that “the case for an increase in the federal funds rate has continued to strengthen” and that it had decided to “wait for some further evidence of continued progress toward its objectives”. In other words, it has set its sights relatively low.

Hike in the Fed Funds rate very likely in December

Everything seems to be on cue for a hike in the Fed Funds rate on 14 December: besides the press release, many FOMC members have indicated implicitly or explicitly their preference for December (Patrick Harker, John Williams, William Dudley and even Eric Rosengren), markets are convinced this will happen (implied probability of almost 80%), while the macroeconomic environment remains encouraging (GDP growth accelerated in Q3, while labour market trends remain positive).

Unless there is a catastrophe, the Federal Reserve is set to jack up the Fed Funds rate in December.”