Key takeaways

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  • As expected, the US Federal Reserve (Fed) raised the upper bound of the federal funds target rate (fftr) to 0.75 per cent from 0.50 per cent and the lower bound to 0.50 per cent from 0.25 per cent
  • This meeting brought the first ever rise in the long run median terminal rate forecast (+0.1ppts to 3.0 per cent). Now the median rate projections point to 3 hikes of 25bps in each of 2017, 2018 and 2019 (compared to 2, 3 and 3 at the September meeting). 2017 and 2019 growth forecasts were revised slightly higher but core inflation was unchanged
  • Yellen’s post-meeting press conference saw a reaffirming of the uber-gradual hiking cycle ahead. Similarly, Yellen highlighted the Fed’s willingness to allow the economy to run “hot” at the press conference, emphasising unemployment (4.5 per cent) is expected to be below the NAIRU (proxied by their longer-run unemployment rate forecast (4.8 per cent).
  • We retain our preference for being underweight developed market government bonds, whilst being overweight a diversified basket of risk assets - including global equities (with a preference for the Rest of the World over the US), short-duration high-yield credit and local-currency EM debt

The facts

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In what became seen as inevitable after the election of Donald Trump – and was further reinforced by continued US data strength – Wednesday saw the US Federal Reserve (Fed) increase the fed funds target rate to 0.75-0.50 per cent in a unanimous decision. While the risk to the outlook was held as “roughly balanced”, the first ever nudge up to the longer-term, or terminal, interest rate forecast and an expectation the economy will continue to perform “well”. (Figure 1).

The post-meeting press conference saw Fed Chair Yellen highlight that the hiking cycle would remain data-dependent, and reassure the market that rate hikes would remain gradual. She reiterated that the potential fiscal boost of the new (Trump) administration remains “uncertain”, and that only some FOMC participations considered it in their forecasts. This was not unsurprising, as several prominent Fed members, including Yellen and Dudley, have stated the need for more details on any future fiscal stimulus before altering their views. The chair also refused to comment on any potential fiscal policy impact on growth or inflation at the press conference.

The inflation outlook will be a key driver of the forthcoming rate hiking cycle. While market inflation expectations have risen sharply following the election they remained acknowledged as “low” but having moved up “considerably” by the committee. Forecasts for core PCE inflation held firm and continue to indicate a trend towards target (without overshooting). Recently, some members expressed a willingness to allow the economy to run hot. This move is further evidenced by the downward shift in the 2017 and 2019 unemployment forecasts, which fell further away from the Fed’s long-term unemployment forecast (a proxy for the NAIRU which ranges between 4.7-5.0 per cent amongst Fed participations).

Meanwhile, the Fed has not seemed concerned that financial conditions have tightened since the election. As Dudley has recently highlighted, this tightening has been driven by an improved economic outlook (including stronger equity markets and higher bond yields), rather than risk aversion as was the case in early 2016. Yellen commented that the rate hike should be seen as a “vote of confidence” in the economy.

Figure 1: Firmer Fed median forecasts

Firmer Fed median forecasts

N.B.. Sept. meeting forecasts in brackets & core PCE forecasts are not collected
Source: HSBC Global Asset Management, US Federal Reserve

Market reaction

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The US S&P 500 currently stands down 0.5 per cent, while 2 and 10 year US treasury yields are 8bps and 5bps higher at 1.24 per cent and 2.52 per cent respectively. Futures markets in Asia point to the Nikkei (0.6 per cent) opening higher. Whilst in Europe the Euro Stoxx 50 futures were little changed compared to before the meeting. In terms of currency markets, the US dollar index (DXY) is up 0.7 per cent to 101.8. Traditional safe haven currencies are lower, with the both Swiss franc (CHF) and Japanese yen (JPY) down 0.7 per cent and 1.1 per cent respectively against the USD. The EUR was down 0.8 per cent. The JP Morgan Emerging Markets currency index is down 0.9 per cent. (All at time of writing)

Investment implications

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As this outcome was in line with our expectations, we maintain our underweight view for US Treasuries (and other core developed market government bonds) which remain overvalued in our opinion. Overall, we continue to hold our preference for risk assets such as global equities (with a preference for the Rest of the World over the US), short-duration high-yield credit and local-currency EM debt, within the context of a well-diversified multi-asset portfolio, from a strategic and long-term perspective.

Disclaimer

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