Good morning.
Today is a happy day. The Federal Reserve is set to raise interest rates for only the second time in a decade, taking us all a further step away from the most traumatic crisis that most of us can remember, and back towards something more easily recognizable as normality. Two-year bond yields, which track short-term rate expectations closely, hit their highest level since November 2008 yesterday.
The near-certainty of a rate rise means that the most important development today will be the guidance that the Fed gives regarding rates in 2017.
Specifically, how many more rate rises will be baked into the ‘dot plot’ that reflects the board members’ expectations for the next two years? What will the central bank’s choice of words tell us about how it will react if, as expected, fiscal policy turns more expansionary under President-elect Donald Trump? To what extent will it hold back on rates, given that the dollar’s rise on the foreign exchange markets already represents a tightening of monetary conditions? And, not least, what will the President-elect tweet in reaction? (His past criticism of ultra-loose Fed policy suggests that he should be supportive, so alarm bells could really start ringing if he’s not.)
Everyone has their view, of course. But it would be a major surprise if the Fed were to mutate overnight into the kind of beast it was under Paul Volcker’s reign in the 1980s. Even though the cycle for inputs such as commodities appears to have turned, wage inflation is still near non-existent (average earnings fell in this month’s payrolls report) and the rapid expansion of the gig economy means that an increasing part of the workforce still has limited access to credit, at least until technology can develop more sophisticated ways of credit scoring.
The strongest argument on the other side – other than the basic need for money to have a real price to serve its function in a capitalist economy – will be the central banker’s atavistic fear of letting an inflation genie out of the bottle. But the Fed – particularly Janet Yellen’s Fed – is likely to wait for hard evidence of a reflationary fiscal policy before it succumbs to such fears.