Fed December hikes: an annual thing - Rabobank

Analysts at Rabobank said that it seems like we can add the Fed’s annual hike to the calendar as a recurring event in December. 

Key Quotes:

"The FOMC launched its hiking cycle in December 2015, promising to hike four times this year, but instead we are heading for another single hike in December.

The minutes of the FOMC meeting of November 1-2 confirmed the now widely held view that the Fed will hike in the final month of the year. Members generally agreed that the case for a hike had continued to strengthen. But a majority of members judged that the Committee should, for the time being, await further evidence of progress toward the Fed’s objectives. Most participants expressed a view that it could well become appropriate to raise the target range for the federal funds rate relatively soon. Some participants noted that recent Committee communications were consistent with a hike in the near term or argued that to preserve credibility, such an increase should occur at the next meeting.

Fed Chair Yellen’s testimony to the Joint Economic Committee of Congress on November 17 suggested that the outcome of the elections a week earlier had not changed the mind of the FOMC. Moreover, she stressed that waiting for further evidence did not reflect a lack of confidence in the economy. Rather, with the unemployment rate remaining steady this year despite above- trend job gains, and with inflation continuing to run below its target, the FOMC judged that there was somewhat more room for the labor market to improve on a sustainable basis than the Committee had anticipated at the beginning of the year. With respect to the impact of the election outcome on the Fed’s rate path she said that there was still a lot of uncertainty about fiscal policy next year and its inflationary consequences.

Since Yellen’s testimony, Q3 GDP growth was revised upward to 3.2% from 2.9%, while the Atlanta Fed’s nowcast for Q4 GDP growth stood at 2.6% on December 6. This is the pickup in growth that the FOMC was looking for in H2, after the disappointing 0.8% in Q1 and 1.4% in Q2. What’s more, the Employment Report for November showed that nonfarm payroll growth continued at a decent pace of 178K, and unemployment fell to 4.6% from 4.9%. Finally, the PCE deflator – which is the Fed’s preferred measure of inflation – rose to 1.4% in October from 1.2% (year-on-year). So the economic data have passed the Fed’s three tests for a rate hike: a pickup in GDP growth, continued labor market improvement, and rising inflation.

What’s more, after a very brief risk-off reaction, the financial markets have responded positively to the election of Donald Trump as the next President of the United States. In combination with Republican majorities in the Senate and the House of Representatives, markets are looking forward to a substantial fiscal policy stimulus boosting the economy. The probability of a December hike priced in by the futures markets has risen to 100%. So unless there is a major disruptive event between now and December 14, the FOMC will raise its target range for the federal funds rate to 0.50-0.75%.

It remains to be seen whether the decision to hike will be unanimous. The September dot plot revealed that three participants did not expect to hike at all this year. However, not all participants have voting rights and the recent economic data – and the anticipated fiscal stimulus by the new administration – could persuade dovish voters. Given the upbeat sentiment in recent weeks, a dissent may not disturb the markets very much. However, if markets have a bad day on December 14, a dissent could make it worse."