Is the Federal Reserve’s outlook for 2017 realistic?

by Dec 21, 2016

If the procrastination of this year is anything to go by, possibly not. 

Last week America’s central bank, the Federal Reserve under it’s Chair Janet Yellen, raised interest rates by 25 basis points off the back of stronger economic data toward the end of 2016. Crucially however it was not just the rate hike that was important, but what she predicted for 2017 in the form of up to 3 more rate rises. Is the Federal Reserve’s outlook for 2017 realistic?

The predictions on hiking rates again next year came at a moment where it looks as if it’s off to the races for investors, many of whom forecast ambitious economic policies under Donald Trump which they think will help the US economy. There has been a big move from bonds into equities after his election, leading to a boom in markets with major US indices hitting record highs over the past weeks. Indeed, the Dow Jones index is currently sitting (at the time of writing) just 20 points off 20,000, a huge milestone. The S&P500 is also reaping big gains.

The upward trend in performance of the S&P500 over the past month (one of the major US stock market indexes). Much of the rise has been attributed to Trump’s election. (Graph taken from the invstr app. Trade this index under #SP500 on the instruments page)

There is plenty of doubt over whether 3 rate hikes next year is a realistic target and some commentators think market optimism might be too gun-ho. For one thing, many economists think that though growth will improve next year, it will still remain under it’s long term trend, meaning that we are seeing possibly too much optimism from the market at the moment. Janet Yellen even said in her press conference that “We are operating under a cloud of uncertainty at the moment”, which is true, as the Fed doesn’t know how it will interact with the Trump administration when it comes to power, especially considering Trump’s criticisms about her during the campaign.

There is little to no certainty in financial markets anywhere across the globe. Countries in Europe are saddled with high levels of unemployment and massive government debt. In Italy a banking crisis is unfolding, while in the UK the final terms of the Brexit negotiations are still yet to be confirmed despite the fact that we are almost 6 months out from the EU referendum.

However, there is no doubt that there are signs of optimism. Money is flowing into equities and foreign investors have even set their sights on historically excluded countries like Russia (the deal concerning Rosneft and Glencore for example). Factors like this could signal positive changes, but investors should pause to take stock of the fact that we are still living in unstable times, while the 2008 financial crisis still hangs over financial institutions and political upheaval threatens the status quo.

The Federal Reserve only raised rates once in 2016, below it’s target. To put it simply, many people think that it procrastinated, and that it may continue to do so into next year despite it’s claims.

Much hinges on whether Trump will stay true to his words about changes to financial regulation and tax cuts for businesses and whether that will actually help the US economy, because if not, not only will the boom’s we are seeing as 2016 draws to a close be unrealistically optimistic, but the words from the Fed about what they see happening next year might be over the top as well. The prominent US economist Joseph Stiglitz questioned Trump’s policies and the Fed’s hike. Writing in The Guardian this week, he said: “Higher interest rates will undercut construction jobs and increase the value of the dollar, leading to larger trade deficits and fewer manufacturing jobs – just the opposite of what Trump promised.”

Many believe despite the current booms, investors should proceed with caution as we peer into another year of uncertainty in 2017.

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