Fed rate hike priced in, markets look for hints at 2017

Investing.com – As markets looked ahead for the Federal Reserve (Fed) to confirm a widely expected 25 basis point hike in interest rates at 2PM ET (19:00GMT) Wednesday, attention was more likely to focus on the updated economic forecasts and particularly the “dot plot” showing policymakers’ expectations for the future path of interest rates, along with the follow-up press conference by Fed chief Janet Yellen, in an attempt to extrapolate how many more increases could be expected in 2017.

Fed fund futures currently put the odds of a hike at this meeting at 100%, according to Investing.com’s Fed Rate Monitor Tool.

Additionally, all 120 economists surveyed in the latest Reuters’ poll agreed that the U.S. central bank would opt to tighten policy, while a Wall Street Journal (WSJ) survey returned similar estimates.

Though there is always a possibility that the markets could be surprised by the lack of a move or a larger 50 basis point move, most experts think the chances are extremely slim based on what the Fed has communicated thus far.

2017 rate hikes

Looking further down the road, markets have priced in the next tightening to occur in June 2017 with odds standing at 61.6%. That is the first policy meeting where the probability passes the 50% threshold.

According to the WSJ poll, economists on average expected the Fed to hike rates three times in 2017, a slightly more aggressive path than the median outcome of two increases that policymakers themselves penciled in with the last dot-plot released in September.

Strategists at Brown Brothers Harriman believe that the Fed will stand pat on expectations for two rate increases in 2017.

“While this is twice as fast as the pace in 2015 and 2016, it fits any definition of prudent and cautious,” they said.

Too early to speculate on possible new fiscal policies

Since the U.S. elections, markets have speculated that incoming President Donald Trump would embark on fiscal policies including infrastructure spending that could serve to not only foster economic growth, but also to usher in inflation, placing additional pressure on the Fed to tighten monetary policy to avoid falling behind the curve.

Several Fed officials have indicated that his election had not changed their outlook because there were too many unknowns with regard to what policies Trump would implement and what their overall impact on the economy would be.

Chicago Fed president Charles Evans said last Monday that it was “still early to have a good idea of what fiscal policies and other events are going to mean.”

“As policies actually are enacted as opposed to just talked about, I think the appropriate thing to do will be to respond to them as they unfold,” Dallas Fed president Robert Kaplan also said.

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New York Fed president William Dudley, known for being the policymaker most aligned with Fed chair Janet Yellen’s way of thinking, also judged last week that “it is premature to reach firm conclusions about what will likely occur.”

However, Dudley did admit that if market expectations for fiscal policy becoming more expansionary were realized, then market participants could be right that the Fed “will likely respond by tightening monetary policy a bit more quickly than previously anticipated.”

In that sense, Yellen is widely expected to take a “wait and see” attitude at the post-decision press conference at 2:30PM ET (19:30GMT), stating that the Fed’s future movements will be data dependent.

Goldman Sachs did point to the fact that their U.S. economists expect a “more sizeable tightening cycle than the market” which could lead to further strength in the dollar as the market re-prices expectations.

“That said, we also think that chair Yellen will continue to emphasize that monetary policy is not on a pre-set course and that the data will dictate the future path of interest rates,” they added.

Spotlight on dot-plot in Fed economic projections

As far as the Fed’s forecast, officials are widely expected to improve estimates on economic growth and unemployment while slightly lifting inflation forecasts.

So once again, focus will likely shift to the Fed’s dot-plot that outlines, anonymously, individual Fed projections for the future path of interest rates.

Currency strategists at Citi suggested that the biggest hawkish risk was that the number of officials that expect three or more hikes in 2017 would increase from the seven dots seen in the September projections.

“The market could probably swallow eight or nine but if it goes above 10, it would probably be viewed as a warning shot about the possibility of a steeper pace (of policy tightening) next year,” they said.

Bank of America-Merrill Lynch appeared to agree despite expectations for Yellen to remain cautious in her press conference.

“We think the risk is that the (Fed) statement and (economic projections) lean hawkish, given the potential for an upward shift in the dots and the possible limited extent of concern about the recent tightening in financial conditions,” these experts said.

“In our view, the risk is for near-term rates to increase and the dollar to strengthen following the meeting,” they concluded.

Markets ahead of the Fed at 9:36AM (14:36GMT) Wednesday

Wall Street opened with a cautious stance on Wednesday ahead of the day’s main event. The Dow Jones slipped 3 points, or 0.01%, the S&P 500 added 1 point or 0.02%, while the tech-heavy Nasdaq Composite traded up 5 points, or 0.10%.

The dollar was trading slightly lower, pressured by a worse-than-expected read on November retail sales. The U.S. dollar index, which measures the greenback’s strength against a trade-weighted basket of six major currencies, was down 0.20% at 100.88.

Meanwhile, gold was trading at $1,166.95 a troy ounce, up 0.60% and holding above the lows of $1,162.95 set on Monday, the weakest since February 4.

The yield on 10-year U.S. Treasury notes was down to 2.433%, from the prior close of 2.480%

As already mentioned, markets had fully priced in Wednesday’s rate hike and June 2017 was the first meeting where odds currently pass the 50% threshold.

For the months straddling June, Fed fund futures priced in only a 29.1% chance of a hike in May while odds stood at 66.4% for July.