Only a few weeks ago the Federal Reserve forecast that US base rates would rise three times within the next 12 months. While many investors seem to take these forecasts with a pinch of salt, a number of high-profile bankers seem to be backing this move by the Fed. So, do markets trust the Fed to deliver on its interest rate policy?
Track record
If we look back over recent times, the Federal Reserve suggested that US base rates would rise twice during 2015 when in fact there was only one rate rise towards the end of the year. The situation was even worse in 2016 with expectations of four interest rate hikes culminating in one rise in December. At this moment in time markets are predicting a one in three chance that the current policy will be fulfilled but not everybody is convinced.
Could 2017 be the year?
There are signs that the US economy is recovering but the emergence of Donald Trump as a superpower is causing some anxiety. On one hand he has business experience and is seen as good for the economy but on the other his international negotiations are tense to say the least. Even during his relatively short time in the White House he has shown himself to be lacking in diplomacy to put it politely.
If you dig a little deeper below the surface there are a number of policies on the horizon which could have a significant impact not only on monetary policy but also fiscal policy. So what does this mean for the market?
Infrastructure spending
If there is one thing which seems certain during Donald Trump’s tenure as President of the United States of America it is a significant increase in infrastructure spending. He has mentioned this on numerous occasions, he is starting to deliver his policies and many expect this increased spending to kick in relatively quickly. While it will depend where this additional investment is spent, there is every chance that it could prompt a stronger economic recovery in the US.
If this was the case, increased infrastructure spending (and spending on public services) could actually prompt the Fed to increase interest rates. The idea being that a growing economy would encourage wage inflation and reduce the necessity for low base rates and low-cost finance. This is based on speculation at the moment but there are certainly signs that Donald Trump is working on a plan to boost the American economy in the short to medium term.
Markets do change
The Fed has come in for a lot of criticism over the last couple of years when short to medium term forecasts have failed to materialise. The fact is that we are living in an economic environment the likes of which nobody alive today has ever experienced. Relatively low base rates are being used around the world to support economies which would struggle if finance costs were to rise significantly. So, it is perhaps a little unfair to be overcritical of the Fed because at the end of the day it is trying to be as transparent as possible in what are fast-moving economic times.