Fed: Key to investors' reaction will be a function of the statement and forecasts - BBH

Research Team at BBH suggests that provided that the Federal Reserve delivers the widely tipped and expected 25 bp hike in the Fed funds target range, the key to investors' reaction will be a function of the FOMC statement and forecasts.  

Key Quotes

“A failure of the Federal Reserve to raise interest rates would be a significant shock and likely spur a dollar sell-off, a Treasury rally, and probably an equity market sell-off.  The likelihood of this scenario is so low that it is not worth much time discussing.  Similarly, a 50 bp move also is highly unlikely.  It would go against everything the Fed has been saying about gradual moves.  It would be an admission of getting behind the curve, and there is no evidence that this is their assessment.”

“There seems to be a broad sense that near midyear, there will likely be some tax cuts and spending increases alongside a tougher, perhaps more mercantilist trade policy.  The details are vague, and how this sits with the fiscally conservative wing of the Republican Party is not clear.  While the intentions and signals of the President-elect have spurred a sizable reaction in the capital markets, more concrete details are needed to begin contemplating the impact on monetary policy.”  

“Therefore (and this is where some investors may be disappointed), the FOMC's economic assessment and most importantly, their forecasts, are unlikely to change very much.  Of course, the part of the statement that updates the economic assessment may be upgraded a notch.  The headwinds that held the economy below trend appear to be transitory as the Fed had anticipated.  Fourth quarter growth looks to be around 2.5%.  Consumption may be a little less robust and trade is looking like a drag.”  

“All else being equal, the appreciation of the dollar and rise in yields would likely have a dampening impact on growth and inflation forecasts.  This may be blunted by the further decline in the unemployment and underemployment rates and the wealth effect.  And given the uncertainties over the new Administration, most Fed officials are likely to be reluctant to change their forecasts much now, when in three months, visibility will be better.”

“Specifically, we expect the median dot show expectations for two hikes next year.  While this is twice as fast as the pace in 2015 and 2016, it fits any definition of prudent and cautious.  A recent Wall Street Journal survey found that among economists three rate hikes are thought likely next year.”

“In her press conference, Yellen will likely deflect any discussion of the new Administration's policies.  However, she can be counted to offer a vigorous defense of the Fed's independence against encroachments.  Given two current vacancies, the expiration of several governor terms in 2018, the new Administration will have the opportunity to change the Federal Reserve significantly without going through the politically and economically sensitive course of direct confrontation.”