Fed's first meeting of 2017
As the Federal Open Market Committee (FOMC) prepares to hold its first meeting of 2017, we do not expect any changes to be announced to the Fed's monetary policy—particularly given Janet Yellen's recent comments that the trend in wages does not warrant the Fed taking further action at this time. The Fed will also likely want to learn more about President Trump's stimulus plans before making any adjustments.
We do, however, expect more clarity from the Fed in its prepared statement, given that there will not be a press conference accompanying the meeting. Of particular importance is the difference between the Fed's "dot plot" and the market's expectations. The dots show the FOMC's consensus expectations of three rate hikes this year and three more in 2018. However, the market expects only four rate hikes in total over the next two years—a significant difference.
What the market expects
This ongoing gap between the market's expectations and the future
Trump's pro-growth measures may be at odds with a Fed bent on tightening
pace of rate hikes shows that there is a kind of fragility in the US markets, particularly given that the reflation trade is underway and there is mounting pressure from the labor market. It is in the Fed's interest to be more precise about the future pace of rate hikes to allow the markets to adjust smoothly, given that financial stability is at the core of the Fed's decision-making process.
We also note that the Trump administration is expected to introduce more fiscal stimulus into a US economy that is already operating at full employment. This should generate more inflation, particularly on wages. As such, we are strongly convinced that the Fed will, at the very least, have to act consistently with the rate-hike path presented in its dot plot. In fact, if there are any surprises, we think they will be to the upside—more hikes, not fewer.
Financial stability is at the core of the Fed's decision-making process
we believe the core issue is the Fed's credibility. The market must be convinced that the Fed is voluntarily behind the curve and will let inflation go up before it acts. It will also not be lost on the markets that the Fed stands ready to cool down the US economy while President Trump is promoting new pro-growth stimulus measures, putting the Fed in a very tricky situation.