Markets still not convinced about faster pace of rate hikes from the Fed

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Trump and Powell

Summary:

  • Jerome Powell nominated to lead the Federal Reserve for the next five-year term
  • FOMC vacancies exposes more inclination to the hawkish side
  • FOMC doves, Kashkari and Evans expected to make way for hawks, John Williams and Loretta Mester
  • Markets complacent about rate hikes in 2018
  • Lack of inflationary pressures and subdued wage growth keeps the markets on the back foot

Trump nominates Jerome Powell

Following a brief period of uncertainty, the markets breathed a sigh of relief as President Trump picked FOMC member, Jerome Powell to head the central bank for the next five years.

The markets viewed this as a sign of continuity to the Fed’s currency policies. The decision also highlighted the fact that the Fed’s plans for a “gradual” rate hike increase remains on the table.

Other candidates who were running for the post of the Fed Chair included Taylor and Warsh. Both candidates were seen to be more hawkish in comparison. Despite the current plans for a gradual pace of rate hikes, the markets are seen to be somewhat complacent about the pace of rate hikes coming next year.

FOMC vacancies increases the risks of a hawkish composition

This comes amid weaker pace of inflation growth and the rotation among the FOMC members next year. It is widely expected that the next set of FOMC voting members will be primarily dominated by hawks.

There are also concerns about the mounting vacancies in the Fed. Although the current Fed chair Janet Yellen’s term ends early next year, there is a possibility for her to remain on the board of governors.

This still leaves nearly four seats vacant next year. The seat for the NY Fed President who is part of the FOMC voting committee will also fall vacant as the incumbent William Dudley is expected to retire early next year.

This puts the choice of nominating the seats to President Trump. With the prospects of the mid-term elections due next year, the selection to the vacant seats remains uncertain. However, it is clear that Trump would most probably bring about a balanced set of members.

Known dovish FOMC members such as Neel Kashkari and Charles Evans are expected to vacate their voting seats who will be replaced by hawkish members that include Loretta Mester and John Williams.

Both incoming members have expressed their hawkish views on rates. Williams indicated his preference for three rate hikes in 2018, while Mester said that she expects an event faster pace of rate hikes in the coming year.

Until the remaining seats are filled, the composition of the FOMC voting members is expected to remain hawkish in the short term. With the uncertainty about the FOMC voting composition, a lot will be left to be seen.

Markets currently expecting to see just one rate hike in 2018

The current market expectations point to just one more rate hike next year. However, the chance that the Fed could hike rates two more times next year remains a possibility.

Even for the December rate hike, the markets were initially reluctant. This changed only after the US economy started to spring with the initial GDP reports for the third quarter posting a 3% annual growth rate.

Added to this, the continued stability in the unemployment rate which is now nearing 4% has managed to somewhat convince the markets of a December rate hike.

For the Fed’s part it has signaled that if rates do not rise quickly enough, there could be adverse implications for financial stability. Fed members have in the past cited the current asset valuations in the context of low-interest rates. In the event of an asset bubble, the Fed does not have many options to deal with it.

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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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