The Fed decision could get Trumped

This article was written by Jasper Lawler, Senior Market Analyst at FCA regulated broker London Capital Group Holdings plc (LON:LCG).

Jasper Lawler, LCG

For reasons of consistency, let’s start by saying this is the most important US interest rate decision this year, just like the seven that preceded it. The December meeting of the Federal Reserve will set the tone for trading in the US dollar as well as stock and bond markets in 2017. On Wednesday the US Federal Reserve is expected to raise rates for the first time in 2016.

Rate hike a foregone conclusion

The first point to make on the Fed meeting is that a rate hike is pretty much a foregone conclusion. Fed speakers have been consistently hawkish in statements since the September meeting. Fed funds futures have the odds of a 25 basis point increase at 100%. The US dollar is unlikely to move much on the decision itself. As is often the case, Fed Chair Janet Yellen’s press conference will likely be more important than the policy decision. The Fed will also release its quarterly economic projections for growth, inflation and interest rates.

The Trump-factor

This FOMC meeting could be extra lively because of the Trump-factor. This is the first Federal Reserve meeting with Donald Trump as US President-elect. Trump’s response or lack thereof could exaggerate or curtail the market reaction to the Fed. Traders would be advised to have Trump’s Twitter feed on screen next to their live stream of Janet Yellen. ‘The Donald’ has previously suggested the Fed suppressed interest rates for political reasons; even saying that Janet Yellen should be “ashamed of herself” for doing so. At the same time he has described himself as “a low rates guy.”

What if Trump reacts?

One of two Donald Trumps could appear after the Fed decision; ‘Twitter Trump’ who bemoans the rate hike as either timed against his presidency or as “too little too late” or ‘Presidential Trump’ who respects the Fed’s independence. Silence could imply Donald Trump will endorse Janet Yellen for a 2nd term as Fed Chair. Criticism of Fed policy from The Donald would make a Yellen second term very unlikely. If Yellen stays as Fed Chair beyond her current term, which ends in 2018, it would presumably mean a lower path of rates rises than if Trump were to appoint a hawk as her successor. We believe criticism from The Donald would lead to a stronger US dollar and a steeper yield curve.

A 2017 Spendathon

Another Trump-effect on this Fed meeting is the prospect of higher government spending next year. Fiscal stimulus should mean higher inflation so markets are pricing in more aggressive monetary tightening, with four rate hikes in 2017. Our expectation is that a muted government spending plan as well as periodic instability in financial markets means there will be three US rate hikes at best next year. Government spending is a touchy subject for many Republicans, so it may not be until the second half of the year, that a bill can be agreed. Any economic benefits of fiscal stimulus, aside from any effect of higher business confidence, will probably not arrive until 2018. The Fed’s economic projections are unlikely to factor in fiscal stimulus until it is actually agreed by Congress.

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