The End Game – Eyes on December Rate Hike

As Things Stand

A probability of a December rate hike now sits at 96% according to FED Fund Futures, which is as good as it gets from the market’s perspective, as close to a sure thing as you can expect with one final set of stats due ahead of the -13^th-14^th December FOMC meeting.

We have seen the FOMC in search of a pickup in economic growth from the slow 1^st half of the year, with calls for a tighter labour market coupled with signs of inflation. As things stand, they’ve got all three:

• Nonfarm payrolls continuing to deliver 150k plus numbers each month;
• Weekly jobless claims hitting levels not seen since 1973 last week and;
• FED’s preferred inflation gauge, the Core PCE Price Index pointed to a 1.7% year-on-year inflation rate, supporting the view that inflation is continuing to move towards the FED’s 2% target.

As voting members continue to digest economic data, we consider the FED’s dual mandate in check. Economic growth accelerated in the 3^rd quarter and the latest economic indicators point to a stronger 4^th quarter, which has brought the hawks out en masse, the “Hawkometer” was sitting at 5-0 last week with not a dove in sight, as five voting members talked up the prospects of a December move.

Sentiment towards a December rate hike has contributed to gold’s 9-month low, the Dollar Spot Index’s thirteen and half year high, driven by a surge in Treasury yields, yields hitting 15-year highs.

It’s not all been about the FED and December’s rate hike however, Trump’s election victory and expectations of a sizeable fiscal stimulus package contributing. FOMC members have joined the markets in considering a likely need to revise rate path projections, inflationary pressures expected to drive the FED away from the low and slow that has been the mantra over the last 18-months.

The Decision

We’ve heard analysts talking about the markets pricing in macroeconomic events, including expectations on monetary policy moves and while we have recently seen a bounce despite a move being priced in, this time around there’s more at stake than just a decision by the FED to lift rates.

Of particular interest will be how the FOMC responds to the presidential election result and Trump’s promise to rebuild America.

We’ve seen central banks call for fiscal policy support, almost in desperation, with the ECB and the BoE having been particularly vocal in recent months. In stark contrast, Trump is looking to deliver.

There are some key economic stats still scheduled for release ahead of the December FOMC, including November’s nonfarm payroll, wage growth figures and inflation related data. While we have seen weak nonfarm payroll figures railroad a rate hike in the past so, our view is that data will need to be quite dire to reverse momentum this time around.

We can certainly expect the Dollar to receive a boost, though the size of a boost will be more dependent upon the economic projections accompanying a hike, rather than the move itself.

The focus on the projections will create a new division within the FED, market classification of the doves and hawks shifting to economic projections, the rate path in particular, and not just whether the FED should lift rates in the next FOMC.

FOMC members speaking last week, who intimated a possible need for a more aggressive rate path included Harker (non-voting member) and Lacker (non-voting member), while the FED chair suggested that more clarity on Trump’s policies would be needed before there is any shift in outlook.

A surge in the Dollar, off the back of an expected rise in Treasury yields, is likely to not just weigh on gold, but also European and emerging market equities, capital flows favouring the Dollar.

U.S equity markets are likely to respond favourably to the move, with a more aggressive rate path considered more of an acknowledgement by the FED that Trump is going to deliver on his policy promise, in support of the U.S economy, though certain sectors will gain at the expense of the more defensive stocks and, while commodities may well feel the heat of the Dollar, the new found optimism to economic growth prospects are likely to offset the effects of Dollar strength.

The devil will be in the details this time around.

This article is written by Michael Grant, a senior analyst at ColmexPro