March Fed Meet

Will the Fed bite the bullet on a rate hike?

As the Fed prepares for the all crucial Fed meet in mid-March 2017, the question is what will be its rate stance. The Fed had hiked rates in December 2016 by 25 basis points after a gap of 1 year. However, it had chosen to maintain status quo in its Feb 2017 policy. The signals are varied at this point of time and it could be a close call on rates. Here is why!

No clarity on fiscal policy…

One of the key reasons for the Fed to maintain status quo on rates in February was to allow the fiscal policy in the US to play out. Among the various promises made by Trump in his election campaign, he had dwelt at length on cutting taxes and investing heavily on infrastructure. While both these were in the realm of fiscal policy, they were likely to have a major bearing on the monetary stance of the Fed. Here is why! A cut in corporate and individual taxes as promised by Trump, would have the effect of boosting spending, growth and economic activity. Similarly, the mega $1 trillion spend on infrastructure was supposed to have a salutary impact on domestic growth due to spillover effects. The two fiscal measures combined were expected to take inflation and employment to higher levels. However, as of now there is no clear indication of Trump’s fiscal stance. This may, probably, force the Fed to be a little more wary when it takes a call on Fed rates in March 2017.

Varied signals emanating…

 For the first time in the last couple of years there are varied signals emanating from the Fed and the Futures market. Normally, the Fed perspective on rates and the Futures trading outlook used to be in sync. That is not the case this time around! For example, the Fed Fund futures market is assigning a probability of just 34% to a rate hike in March. On the hand, Janet Yellen has adopted an extremely hawkish language. In fact, she has gone to the extent of hinting that a March rate hike may leave room for further rate hikes during the year. Fed futures markets are of the view that; considering the lack of clarity on the fiscal front and the fluid global scenario, the Fed may choose to hold rates in the March meeting.

 Why rate hike is a possibility…

In fact, influential market voices like Mohammed El Erian have observed that markets were being too sanguine of the risk of rate hikes. He may be right! Inflation is going higher, the US is almost at full employment and PMI and spending are picking up. Remember, Trump has lived up to most of his election promises and his tax cuts and infrastructure spending plans also may be announced soon. That will leave the window open for one rate hike of 25 basis points taking the Fed rate level to 075-1.00%. Probably, the Fed may look to pause after that! ©

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