Fed policy beyond a mid-December rate hike – Wells Fargo

Gary Schlossberg, Research Analyst at Wells Fargo, suggests that the financial markets’ non-reaction to Italy’s “no” vote on constitutional reform removed the last obvious hurdle to a second rate increase by the Federal Reserve at next week’s FOMC policy meeting marking the one-year anniversary of the central bank’s first rate hike in over a decade.

Key Quotes

“Last year’s initial attempt at interest-rate “normalization” quickly fizzled amid fresh turbulence in China’s financial market and the latest in recurring U.S. growth slowdowns during an unusually long, but weak, economic expansion. Still unclear is if its second attempt at a return to the “old normal” in the financial markets will come up short again. An accelerated, post-election “reflation trade” in the financial market is a vote of confidence by investors in a growth and inflation backdrop supportive of a sustained “up cycle.” Still unclear, however, is whether investors’ expectations will be validated by economic data providing the starting point for determining the timing and frequency of policy moves beyond next week.”

“Pre-election forecasts centered on 2%-2½% economic growth in 2017, adequate enough to support further inroads against unemployment, firmer wage-price inflation and two rate increases by the Federal Reserve. Hoped-for stimulus could kick in as early as the latter part of next year if Congress and the new administration move quickly, perhaps accommodating an extra rate increase by the Federal Reserve lifting the Fed funds rate a full percentage point from its current ¼%-½% targeted range.”

“Politics Ascendant. Taken together, fiscal and other policy unknowns are just one of several political issues capable of sidetracking planned interest-rate increases in the coming year. Among the “known unknowns” are potential after-“shocks” from Sunday’s Italian no vote on efforts to recapitalize the country’s ailing banks and avoid disruptive bail-outs capable of adding to the strains on a still-fragile European banking system. A more “globalized” Fed, responding to more integrated international markets, already is more attuned to the adverse consequences of overseas disturbances on “orderly” market conditions in the U.S. Next year’s general elections in Germany, France, the Netherlands and, in all likelihood, Italy are a series of potential flashpoints, risking a further spread of populism striking at the heart of the European Union (EU) and the Euro-zone’s common currency.”