AI view: US interest rate hikes in 2017

Just when the markets were starting to think some semblance of normalisation was on the horizon, particularly as regards interest rates, the US presidential election in November threw up new uncertainties. 

The big question now is: what will Donald Trump's policies turn out to be, and what impact are they likely to have on the economy and, in turn, the pace and timing of rate hikes? This has major implications for investment portfolios around the world.

AsianInvestor spoke to market experts to make 10 predictions for the coming Year of the Rooster. Today we feature number two, after considering yesterday whether Trump would spark a trade war.

How many rate hikes will the US make this year?
Answer: Two

Bond markets and the Federal Reserve for once almost agree on the likely number of US interest rate rises in 2017. The markets say two and the US central bank says three.

By contrast, one year ago the markets were forecasting one to two for 2016 and the Fed four. The bond markets won, but it’s possible the Fed ends up delivering four rates rises over two years.

There is complete unanimity that rates will go up and that financial markets are far better prepared for this structural adjustment than in 2013, when they threw a taper tantrum. Still, there may be volatility along the way; market transitions are rarely smooth.

The biggest swing factor will be the impact of President Trump’s promised fiscal expansion on inflation and the Fed’s response to it.

Economists point out that Trump’s promised fiscal spending is coming at a time when employment is full and wages are rising. For example, even on the wider measure of underemployment, the US recorded a 9.3% rate in November compared to a 10.66% long-term average.

In this environment, Trump’s policies could push inflation up to the 4% to 6% level. But most economists agree that would be no bad thing, making up for a decade’s deflationary trend.

The Fed is also unlikely to overact with aggressive rate hikes that crippled the US economy. Fed chairwoman Yellen herself has said an “abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession.”

In such an environment fund managers advocate cyclical stocks over defensive equity investments such as Reits. They also prefer fixed income trades with a higher carry such as US high yield and caution investors to stay at the short-end of the curve, which is better protected against rate rises.

Treasury inflation-protected securities, or Tips, could also be a top tip.