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US Interest Rate Rise: Not If But March

Economists are used to getting egg on their faces. Since we argued nearly two weeks ago that the next Fed rate hike would be in June, the Fed (notably FOMC chair Janet Yellen and NY Fed president Bill Dudley) has signalled that it expects to raise rates on 15th March. The only stumbling block is the February employment report due this Friday. According to Bloomberg, the market reckons a March rate hike is a 98% probability.

Why the sudden shift in FOMC policy after three years of dovish noise and behaviour? We can think of three possible reasons.

First, business confidence has soared since 8th November – the chart shows three mainstream business indices. This is not surprising in view of the Trump agenda of corporate tax cuts, deregulation and infrastructure spending. However, it is debatable how much of this agenda will make it into reality. Moreover, strong business confidence is not the same as a strong economy. Barclays and the Atlanta Fed both reckon first quarter growth is running at a moderate 1.8% pace, using “now-cast” calculations.

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Second, the US stock market is hitting new highs. The Fed often treats stock indices as a “wisdom of crowds” indicator of the looseness or tightness of monetary conditions. The Dow, S&P and Nasdaq have all recorded new all-time highs over the past week, suggesting an easing of monetary settings. The Fed has decided to lean against this easing.

Third, there will be a change of personnel on the committee. There will be three new people – Trump nominees – on the FOMC this year and Janet Yellen is very likely to be replaced early next year. While Donald Trump is unpredictable and has railed against low interest rates in the past, he is unlikely to welcome steep interest rate increases. Perhaps the current set of policymakers decided to tighten policy while they can.

It is arguable whether this sudden shift in monetary policy towards early rate hikes is sensible but it looks as though the decision has been made. Looking ahead, two more increases, possibly three, look likely.

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