Sunday, January 08, 2017

Question #6 for 2017: Will the Fed raise rates in 2017, and if so, by how much?

by Bill McBride on 1/08/2017 12:20:00 PM

Last week I posted some questions for 2017: Ten Economic Questions for 2017. I'll try to add some thoughts, and maybe some predictions for each question.

6) Monetary Policy:  The Fed raised rates this month, and now the question is how much will the Fed raise rates in 2017?  The market is pricing in three 25 bps rate hikes in 2017, and most analysts expect two to three hikes in 2017.   Will the Fed raise rates in 2017, 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 in 2015 I finally argued a rate hike was likely (although I thought we'd see more than one in 2015).  The Fed raised rates in December 2015, and then once again in December 2016.

Currently the the target range for the federal funds rate is 1/2 to 3/4 percent.

As of December, the FOMC members see the following number of rate hikes in 2017:

25bp Rate Hikes
in 2017
More than Four2

Analysts are being cautious on forecasting rate hikes, probably because they forecasted too many hikes over the last few years. However, as the economy approaches full employment, and with the possibility of fiscal stimulus in 2017, it is possible that inflation will pick up a little - and, if so, the Fed could hike more than expected.

Analysts at Merrill Lynch recently wrote:
We expect the Fed to hike once in 2017, but the risks are to the upside. Once fiscal stimulus kicks in, we expect the Fed to hike faster – we forecast 3 hikes in 2018.
Tim Duy noted Friday: Solid Employment Report Keeps Fed On Track
The labor market finished out the year on a solid note. Solid, not spectacular, and largely consistent with the Fed's expectations. Consequently, the final employment report for 2016 should not impact the Fed's median forecast for 75bp of rate hikes in 2017.
The economy is now at a point where a sudden boost in activity would prompt the Fed to accelerate the pace of rate increases. This employment report, however, suggests this isn't happening just yet.
Bottom Line: A solid report largely consistent with expectations among monetary policymakers. Hence it should have little impact on interest rate forecasts for the coming year. But watch out for upside risks to the outlook; the economy gained some traction in the final months of 2016. It is reasonable to believe that traction will hold in 2017.
The number of hikes depends on the economic outlook and inflation. There are significant uncertainities concerning fiscal policy, and some of the proposals could boost economic growth (as an example, if there is a real infrastructure spending program), and some could impede growth (like a significant trade dispute).

My current guess is the Fed will hike twice in 2017.

Here are the Ten Economic Questions for 2017 and a few predictions:

Question #1 for 2017: What about fiscal and regulatory policy in 2017?
Question #2 for 2017: How much will the economy grow in 2017?
Question #3 for 2017: Will job creation slow further in 2017?
Question #4 for 2017: What will the unemployment rate be in December 2017?
Question #5 for 2017: Will the core inflation rate rise in 2017? Will too much inflation be a concern in 2017?
Question #6 for 2017: Will the Fed raise rates in 2017, and if so, by how much?
Question #7 for 2017: How much will wages increase in 2017?
Question #8 for 2017: How much will Residential Investment increase?
Question #9 for 2017: What will happen with house prices in 2017?
Question #10 for 2017: Will housing inventory increase or decrease in 2017?