US Fed hike: When a tiny move matters

Thursday, December 15th 2016, 3:09PM

by Harbour Asset Management

As widely anticipated, the US Federal Reserve lifted the US Fed Funds Rate by 25 basis points this morning, to a new target range of 0.50% to 0.75%. This is the first and only move in the US Fed Funds Rate in 2016, following the last move in December 2015.

The main news in today’s decision was the move in the so-called dot plots, which capture the US Fed Funds projections of individual FOMC members. For the end of 2017, the median projection has been revised up from 2 additional hikes (at the September projection) to 3 additional hikes, which would see the US Fed Funds at 1.25% to 1.5% by the end of 2017.

US Federal Reserve Chair, Janet Yellen, was at pains to underplay the revision as “tiny”.

However, it was this move in the dot plots for 2017 that created the main reaction to the statement, with the US 10 year bond yield rising over 10 basis points to nearly 2.60% - its highest level in 2 years. Equity markets – particularly defensive bond proxies – also weakened on the news.

While the US election victory of Donald Trump has arguably been the biggest news since the last FOMC meeting, the press statement today was totally silent on the outlook for US fiscal policy or the significant rise that we have seen in the US dollar and US bond yields since the US election.

At the press conference, Janet Yellen was met with a barrage of questions on the implications of the new Trump administration, and in particular whether a more expansionary fiscal policy would see a faster tightening in US monetary policy. In response, Yellen noted that with the lack of any specifics on an actual fiscal package, it was far too early for the US Federal Reserve to comment in any detail, or to respond to the market’s reaction to the Trump election victory. That said, for some individual FOMC members, the change in outlook for US fiscal policy may have been one factor that influenced them to revise up their dot plots for 2017.
In the past, both Janet Yellen and her predecessor, Ben Bernanke, have been advocates of more active fiscal policies, to take the pressure off central banks that have run out of room with interest rates at record lows. When asked about this at the press conference, Yellen noted that those arguments had been made when the US unemployment rate was significantly higher; whereas (with the unemployment rate below 5%) it was much harder to argue now that a jolt of US fiscal stimulus was needed to use up spare capacity.

In effect, Yellen let slip that if Trump is able to deliver on his fiscal promises, any future revisions in the FOMC’s dot plot would not be “tiny”. We are of the view that this serves to reinforce the sentiment of bond and foreign exchange markets, and the rotation within equity markets, since the US election.

This column does not constitute advice to any person.
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