Federal Reserve officials keep breaking their promises, so it’s little wonder financial markets have stopped taking officials at their word.
Fed officials were nearly unanimous at the start of 2016 in predicting the central bank would raise interest rates four times that year. It ultimately did so just once, at the very last meeting of the year.
Now, the Fed is claiming they could move three times this year. But investors are not so sure.
They have reason to be sceptical. Policymakers are quick to point out their guidance on rates is just a forecast, not a pledge, even though it is often viewed as such. In addition, market perceptions have shifted in part due to a renewed sense that Donald Trump is actually going to keep some of the anti-trade promises he made during the campaign, which could threaten economic growth and lead the Fed to take a more dovish route than expected.
Market enthusiasm seems to have peaked when Trump took office and started to actually to fulfil some of his harsher protectionist promises. Trump quickly ripped up the hard-fought Trans-Pacific Partnership agreement negotiated by the administration of President Barack Obama and has vowed to renegotiate the North American Free Trade Agreement and impose a border tax on imported goods. He and his team have also unfairly accused top trading partners China and Germany of manipulating their currencies, setting the stage for a confrontation.
Importantly, Trump will have the opportunity to reshape the Fed as Janet Yellen’s term expires, making it even more difficult than usual to foresee the future path of policy.
This chart from Deutsche Bank economist Torsten Sløk shows just how much doubt investors have about aggressive future Fed action. Market expectations about the probability of three hikes in 2017 have been slowly but steadily dropping since the December FOMC meeting.
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