EUR 68.40 For Business Accounts Only

The Fed's Crystal Ball Grows Cloudy

​A 25bps increase at next week’s meeting has already been priced in and there will be little drama around that. However, the imminent policy action has overshadowed a more significant development: the divergent responses by the Fed and the market to a Trump presidency.

The Fed views a Trump presidency as a source of tremendous uncertainty. Several Fed speakers have noted the potential for significantly different economic policy in 2017. The unpredictability of political and economic outcomes has clouded the Fed’s crystal ball substantially. In our view, December will be an inflection point and the Fed will pivot away from its fairly active and hawkish mode of recent months to a stance that is more cautious and ambiguous entering 2017.

Meanwhile, markets seem more certain and have responded boldly. They have aggressively priced in higher inflation, deficits and policy rates. This has sent long-term yields soaring and the dollar higher. Indeed, markets may be “priced to perfection” in this regard.

In our view, there is a growing risk that markets will be “disappointed” by economic data, fiscal policy or Fed rhetoric in the first quarter and have to reconsider their aggressive pricing of rates and the dollar.