Is A December Rate Hike Fait Accompli?


by Miles Franklin:

The Federal Reserve is holding another policy meeting this week and financial markets are pricing in that a 25 basis point rate hike is almost guaranteed. Yet given recent Fed commentary, it seems like the move is hardly fait accompli.

That a rate hike would be a favored probability is reasonable enough. However given the Fed’s track record, as well as recent comments by Janet Yellen and John Williams, there is some question as to whether the rate hike is really a done deal.

In November Yellen made a few bizarre comments that seemed rather out of line with her previous forecasts. In particular she mentioned that the “probability that short-term interest rates may need to be reduced to their effective lower bound at some point is uncomfortably high, even in the absence of a major financial and economic crisis.”

How does that reconcile with the Fed’s guidance that rates will continue to rise? What’s also interesting to hear is how she mentions this scenario even absent another crisis. Which has of course become inevitable due to past Fed policy.

Yet how are the markets responding?

According to Kitco, “JP Morgan pointed out that it estimates five more Fed rate hikes between December 2017 and December 2018.” Which would seem to be in-line and reflective of the general belief in the mainstream Wall Street community.

Yet at the same time Yellen is talking about the uncomfortably high probability of lowering rates again, apparently that’s still not enough for San Francisco Fed president John Williams. According to Reuters, Williams believes the solution is negative interest rates and income targeting.

“We will all be better able to contain the next economic recession if we develop approaches that succeed even when many countries are simultaneously constrained by the lower bound.

Strategies that central banks should consider including not only the bond-buying and forward guidance used widely in the last recession, but also negative interest rates that was used in some non-U.S. countries, as well as untried tools including so-called price-level targeting or nominal-income targeting. Central banks may also want to consider setting a higher inflation target, he said.

The Federal Reserve may well will raise interest rates by a quarter-point this week. Although the scenario where they surprise the market by not hiking would seemingly be greater than the almost 0% it’s being priced in as. And over the next year, the probability that there is a deviation from J.P. Morgan’s assessment of five rate hikes seems incredibly likely.

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