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Yellen rolls with the (Trump) punches

Last night’s decision by the US Federal Reserve to raise interest rates by 0.25% was arguably the least interesting part of the FOMC meeting and press conference given it had been priced in as a virtual certainty by investors. The more interesting aspect was what happened the Fed’s ‘dot plot’ or members’ projections for changes in the Fed funds rate over the next few years.

The median expectation for interest rate changes rose to price in around 0.75% of rate hikes next year which was higher than for the previous meeting in September (0.5%). Meanwhile growth and inflation forecasts were largely unchanged. During her press conference Chair Yellen stressed that the changed interest rate expectations were the result of a slight shift in views from some FOMC members. This should at least alleviate possible concerns that the Fed is turning considerably more hawkish.

During the press conference she also emphasised that the hike and the changed expectations should be viewed positively by investors that the economy was gradually improving. We agree with this assessment – previous cycles have taught us that the vast majority of time equities can perform well in the face of interest rate hikes as long as the economy is improving.

The question and answer session featured a barrage of direct and indirect questions about the possible impact of President elect Trump on the Fed’s outlook. She noted that the economy didn’t need any direct stimulus to reduce unemployment but suggested this could help longer term US productivity if exercised wisely. In addition she mentioned that some Fed members were including some fiscal stimulus in their assessment as part of the decision to raise interest rate expectations for 2017/18 while others hadn’t. So again, the move to price in 0.75% of hikes in 2017 should not be seen as a direct response to Trump’s election.

Does this change our view for the year ahead? Not really. Last year we felt Fed expectations for four rate hikes in 2016 was unrealistic. This year’s call for 0.75% in 2017 is much more realistic. As long as the economy performs in line with Fed expectations then in our view stock markets should be able to respond in kind in 2017. The Fed’s expectations should also feed into a stronger outlook for the dollar and higher bond yields in 2017, two key messages in our outlook for the year ahead.

Tom McCabe – Global Investment Strategist, December 15 2016