Wednesday, January 06, 2016

Question #5 for 2016: Will the Fed raise rates in 2016, and if so, by how much?

by Bill McBride on 1/06/2016 04:36:00 PM

Earlier I posted some questions for next year: Ten Economic Questions for 2016. I'll try to add some thoughts, and maybe some predictions for each question.

Here is a review of the Ten Economic Questions for 2015.

5) Monetary Policy: The Fed raised rates in December, and now the question is how much will the Fed raise rates in 2016? The market is pricing in two 25 bps rate hikes in 2016, and most analysts expect three to four hikes in 2016. However, some analysts think the Fed is finished, the so-called "one and done" view. Will the Fed raise rates in 2016, and if so, by how much?

For years I made fun of those predicting an imminent Fed Funds rate increase.  Based on high unemployment and low inflation, I argued it would be a "long time" before the first rate hike.   A long time passed ... and last year I finally argued a rate hike was likely (although I thought we'd see more than one).  Now it seems likely the Fed will raise rates further in 2016.

Tim Duy at Fed Watch expects four rate hikes in 2016:

The Federal Reserve will continue to hike rates, slowly. I expect that economic conditions will be sufficient for the Federal Reserve to justify 100bp of rate hikes in 2016. Although the Fed will not want to appear mechanical in its normalization process, they will likely find themselves hiking every other meeting beginning in March. They will be slow to begin the process of "normalizing" the balance sheet, although I expect that they will be fully engaged in that conversation by the middle of the year. That conversation will take on more urgency if they have difficulty controlling short rates with their new tools.
And Fed Vice Chairman Stanley Fischer thinks four hikes is "in the ballpark", from Bloomberg: Fed's Fischer Says Four Rate Hikes in 2016 ‘in the Ballpark’
Federal Reserve Vice Chairman Stanley Fischer said policy makers’ forecasts predicting four interest-rate increases in 2016 were “in the ballpark,” though China’s slowing economy and other sources of uncertainty make it difficult to predict the path of policy.

“The reason we meet eight times a year is because things happen, and as they happen you want to adjust your policy,” Fischer said in an interview Wednesday on CNBC.
Of course the Fed will be data dependent and inflation is the key to the number of rate hikes in 2015.  From the December FOMC minutes:
In determining the size and timing of further adjustments to monetary policy, some members emphasized the importance of confirming that inflation would rise as projected and of maintaining the credibility of the Committee's inflation objective.
If inflation picks up, then four rate hikes is probably "in the ballpark".  If inflation stays low, then we will see fewer rate hikes.

I've seen several people arguing the Fed will be cutting rates by the end of 2016 - I think that is unlikely.  Instead I think the Fed will be cautious - and they will not want to reverse course.   Right now I think something around three rate hikes in 2016 is likely.

As an aside, the old saying on Wall Street with regards to rate hikes is "3 steps and a stumble" meaning three hikes and the stock market stumbles.  I don't think there is an validity to the saying, but I expect to hear it on CNBC in 2016!

Here are the Ten Economic Questions for 2016 and a few predictions:

Question #1 for 2016: How much will the economy grow in 2016?
Question #2 for 2016: How many payroll jobs will be added in 2016?
Question #3 for 2016: What will the unemployment rate be in December 2016?
Question #4 for 2016: Will the core inflation rate rise in 2016? Will too much inflation be a concern in 2016?
Question #5 for 2016: Will the Fed raise rates in 2016, and if so, by how much?
Question #6 for 2016: Will real wages increase in 2016?
Question #7 for 2016: What about oil prices in 2016?
Question #8 for 2016: How much will Residential Investment increase?
Question #9 for 2016: What will happen with house prices in 2016?
Question #10 for 2016: How much will housing inventory increase in 2016?