Trump Spell on Markets Hasn’t Swayed Economists Judging Fed Path

  • Gradualism to stay in place until Fed sees actual fiscal plan
  • Stronger dollar to continue weighing on growth next year

Fed's Key Question Is How Fast to Raise Rates: Reinhart

Donald Trump’s election victory provoked a big shift in bond market expectations for U.S. growth and inflation but economists still only expect the Federal Reserve to raise interest rates twice next year.

Respondents to a Bloomberg survey also predict that if the Fed announced a rate hike at the conclusion of its two-day meeting on Wednesday in Washington, which is viewed as a foregone conclusion, it won’t move again until June.

“The Fed doesn’t want to be premature judging economic policies,” said Priya Misra, head of global interest rate strategy at TD Securities LLC in New York. “They are not going to give up on a strategy that has served them well -- staying lower for longer to get more people into the labor force.”

U.S. equities have rallied and bond markets slumped since Trump’s Nov. 8 election win as investors bet his campaign promises for tax cuts and infrastructure investment will boost growth and lift inflation. Ten-year Treasury note yields have jumped to 2.45 percent compared to 1.83 percent the day before the vote, and the Standard & Poor’s 500 stock index is up 5.9 percent.

Still, economists are confident that the gradual pace of rate hikes the Fed first signaled last December is going to persist into 2017 and will be the dominant message from this week’s policy meeting as officials wait to see what policies Trump actually puts in place.

Wait for June

If Fed officials raise the benchmark lending rate this week, the next hike will be in June, according to an average 35 percent probability assigned by survey respondents. They attributed a 25 percent probability of the next hike occurring in March, and a 12 percent chance of the Fed waiting until November.

When the Fed raised interest rates a year ago, it used the word “gradual” twice to describe its policy outlook, and said the federal funds rate is “likely to remain, for some time, below levels that are expected to prevail in the longer run.” That phrasing remained in the statement in November.

Laura Rosner, senior U.S. economist at BNP Paribas in New York, said the language is a form of forward guidance and it’s too early to remove it.

“It is possible that they take out a little bit of the gradualist rhetoric eventually,” Rosner said. “But March seems too early. It took the Fed a long time to conclude we are in a low inflation, low-rate world and I wouldn’t expect their assessment to change quickly.”

Labor Slack

Some 61 percent of survey respondents backed up their case for gradualism by saying the U.S. economy is “close to but not at full employment,” while another 10 percent said “substantial slack remains” in the labor market.

The unemployment rate stood at 4.6 percent in November, the lowest in nine years, while a broader measure that includes involuntary part-time workers was still above pre-recession levels.

Eighteen of the 41 economists surveyed said Fed officials’ median estimate for the lowest sustainable unemployment rate, a proxy for full employment, would fall by more than 0.1 percentage point from the September estimate of 4.8 percent. Some 37 percent of economists in the survey said the median would remain the same this month.

Almost two-thirds of the economists said that by March U.S. central bankers will project a faster pace of tightening in their quarterly economic projections for the next two years than they will this month. One third said they wouldn’t alter the path in March.

Almost 40 percent of economists said the Fed moving ahead of other major central banks in its interest-rate tightening cycle may lead to slower growth next year due to the drag on exports. A third said the most important consequence of policy divergence would be tighter financial conditions and the potential of slower growth from currency appreciation.

“The stronger the dollar the greater the likelihood you will see a slow, gradual pace of rate hikes” from the Fed, said Karl Haeling, head of strategic debt distribution at Landesbank Baden-Wuerttemberg in New York. “It definitely keeps a lid on inflation and limits the degree to which there is any acceleration in growth.”

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