The Fed Is Finally Going to Raise Rates This Week, and the Market…Yawns

Debate surrounding the Federal Reserve raising interest rates has been raging all year. Coming into 2016 the Fed expected to raise rates four times, while the market was pricing in just two. The disconnect in expectations was a main focus for bond investors and was likely to be a main driver of returns–positive if the Fed came the market’s way and negative if the market had to adjust to the Fed. We sit here now in mid-December with the last meeting of the year on Wednesday, and it appears that now is the time. So why is the market yawning? For two reasons, we think:

One, the likely 25 basis point rate increase has been telegraphed for months by the Fed through both formal communication via official press conferences and meeting statements , and through informal comments in speeches and interviews. Fed officials have been so transparent that the market is pricing in a 100% chance of a hike–a rarity these days. This means that despite the rate increase, bond yields are unlikely to move at all, absent some other market event.

Second, the bond market’s attention has turned from monetary to fiscal policy with the November election results. As we’ve written about in recent weeks, the Trump administration is promising a heavy dose of fiscal stimulus through infrastructure spending and tax cuts, along with touting more protectionist trade policies. These actions all have the potential to be inflationary, and the recent selloff in the bond market reflects the possibility that such measures are passed.

The trick for the Fed will be determining how to account for this new world in its outlook for future economic and interest rate projections. The Fed will release its expectations for these data points following the meeting, and Fed Chair Yellen will hold a press conference to articulate the materials. We think it is likely the Fed plays down the hype surrounding the fiscal stimulus possibilities, instead preferring to maintain its expectation for a slow and steady path to future rate increases. After all, the Trump plans are just that, plans. The details surrounding what will actually be implemented, the timing of implementation, and the effectiveness of whatever policies will be put into place are key. Like us, we think the Fed will find it prudent to wait and see.