Mark Schlarbaum on Next Rate Hike
2016 has been the year of unexpected outcomes in the markets according to. No one was anticipating a yes vote on Brexit, and fewer still expected a Donald Trump presidential victory. One of the next major global financial events the markets are watching is whether the U.S. Federal Reserve (the Fed) will raise interest rates during its two-day meeting scheduled for December 13th and December 14th. Wall Street Analysts, the media, and even we here at KraneShares, all expect the Fed will raise rates by 0.25%, which will have a huge, yet predictable effect on the markets. However, as 2016 – the year of unexpected outcomes – has taught us, we are still watching for any event that could possibly delay the rate hike very closely.
Why Mark Schlarbaum believes the rate hike will happen
Fed Chairwoman Yellen in her most recent testimony before the Joint Economic Committee on November 17th indicated that a rate hike is coming soon. In response to a question about impact of the election, Yellen stated, “evidence so far on the economy is consistent with the judgment that the Federal Open Market Committee (FOMC) reached in November, namely, a rate hike is likely to come soon.” Additionally, Chairwoman Yellen indicated in her testimony that the Fed would act quickly to raise rates in a more stimulative spending environment, which is consistent with president-elect Trump’s stated policy objectives.
According to one of the most reliable Federal Reserve predictors, the Fed futures market, a U.S. rate hike appears to be one of the few certainties of the year. Fed futures are used by futures traders to express their view on what interest rates will be on a month to month basis. Depending on where the futures are pricing interest rates, the market derives the probability of whether the Fed will raise or lower rates at the next meeting. The Fed Futures have priced in a 100% chance of a rate hike at the next Fed announcement scheduled for December 14th.
Possible causes for delay
In the minutes from November’s Fed meeting there was some fear of the uncertainty of the markets’ reaction to a Trump win, but the broad stock market has risen strongly with the S&P 500 up 3% since the election and the Dow up 4.5%, alleviating concern of a negative market reaction to Trump’s unexpected victory.
There are also several Fed Governors speaking over the next two weeks who all have their own independent view of the economy and can express their own opinions, which adds an element of uncertainty to the probability of a rate hike.
A U.S. jobs report this Friday looms as a potential detractor should the numbers prove weaker than expected. However, the market backdrop is incredibly strong leading up to the decision. The Bloomberg Dollar Spot Index, which tracks the currency against 10 major peers, is up 3.9% this month and 1.8% this year. The dollar has gained 3.5% in November to $1.0593 per euro and 7.3% to 113.06 yen. The 10-year note yield was little changed last week 2.36%, after reaching the highest level since July 2015, according to Bloomberg Bond Trader data. The 2% security due in November 2026 traded at 96 26/32. The yield on the two-year note reached 1.17%, the highest since 2010. It would take a very negative jobs number to raise doubt in traders that the rate hike would not happen this year.
We believe the one possible detractor with the most gravity is lingering uncertainty around the new Presidential administration taking office on January 20th. There is potential the Fed could push the decision until their next meeting in order to monitor what happens to the economy when President-elect Trump takes office. While we view this as the most plausible cause for a potential delay, the likelihood of it actually having an effect is small.
Future rate hikes likely
With the market seeing a rate hike at the Fed’s Dec. 13-14 meeting as a certainty, attention is shifting to next year, where futures show a more than 65 percent chance of further rate hikes by June. The market will carefully analyze the December Fed statement which should provide insights into 2017 and set the stage for another very interesting year in the Global equities, fixed income and currency markets. As an investor getting the direction of U.S. interest rates and determining the strength or weakness of the U.S. dollar are perhaps the most important elements in determining market returns all over the world right now.
About the Author
Mark Schlarbaum, Irvine, California