Coverage: Markets cautious ahead of Fed meeting

With the Federal Reserve Board’s committee that oversees interest rates meeting this coming week, investors will be cautious ahead of the decision.

Caroline Valetkevitch of Reuters has an overview:

While investors have long anticipated the Fed will raise rates at the Dec. 13-14 meeting – in what would be its first such move in a year and second in nearly a decade – the worry for some stock investors is that the Fed takes a more aggressive stance on inflation and future hikes.

Stocks have set a string of record highs since the Nov. 8 election on hopes of a pickup in U.S. economic growth, thanks to President-elect Donald Trump’s promises of increased infrastructure spending, lower taxes and easier regulations.

U.S. investors seem optimistic about prospects of future growth, but the question remains if the Fed does as well.

The U.S. central bank should announce new economic forecasts next week, along with a rate hike. If inflation is expected to pick up quickly, the Fed may need to raise rates faster than investors expect, and that could be a negative for U.S. stocks.

“If they believe that inflation is going to march higher and more rapidly … That would give the market reason to pause,” said Quincy Krosby, market strategist at Prudential Financial in Newark, New Jersey.

Paul Davidson of USA Today examines whether President-elect Donald Trump will mean more frequent rate hikes:

For now, economists don’t expect Fed policymakers to weigh such hypotheticals as they draft their quarterly projections for rate increases over the next few years. Even so, with unemployment falling rapidly and inflation finally picking up, Fed officials likely are no longer inclined to call for slower rate hikes over the long-term, as they have in each of their previous forecasts this year amid headwinds such as weak productivity growth, economists say.

“Unemployment is falling toward levels that are arguably below stable inflation,” says Tim Duy, a University of Oregon economics professor and author of the Fedwatch blog.  Yet he says the Fed will almost certainly reiterate that rate increases will be gradual.

In November, the jobless rate dropped to 4.6% from 4.9% the previous month. That’s already below the 4.8% that the Fed has deemed the lowest average rate sustainable without generating excessive inflation, or rapid price increases that decrease consumers’ purchasing power and especially hurt savers and those on fixed incomes. Low unemployment typically pushes up wages as employers compete for fewer available workers, and price increases typically follow as the firms scramble to maintain profit margins.

That doesn’t mean persistently low inflation is poised to suddenly spike.While an inflation measure closely monitored by the Fed rose from 1.2% to 1.4% annually in October as the effects of low gasoline prices faded, that’s well below the Fed’s 2% target.

Still, it was the fastest pace in two years. And annual wage growth hit a seven-year high in October and has climbed steadily since early 2015 in “a further signal that inflation is firming,” Barclays economist Michael Gapen wrote in a note to clients.

Sam Fleming of the Financial Times says investors will be focused on the Fed’s 2017 forecast:

The market’s focus will, however, be squarely on the central bank’s outlook for borrowing costs in 2017 and beyond, with many investors betting that policymakers will step up the pace of rate increases.

This is because Donald Trump and House Republicans have been pledging to slash taxes, which could lift growth and the budget deficit — prompting the Fed to act to rein in any inflationary pressures.

Top Fed officials do not, however, want to jump to premature conclusions about the implications of Republicans’ plans. Janet Yellen told Congress last month that it is too early to assess the possible impact of future tax and spending plans, and she is likely on Wednesday to stick to her message that rates will rise only gradually.

“I think the Fed will remain cautious, especially initially, until the details of what exactly will pass in Congress are known,” said economist Roberto Perli of Cornerstone Macro. “I think two rate hikes in 2017 remain a good base case, considering that it will probably be the summer before Congress approves an economic package and such package is likely to start taking effect late in the year. Depending on the specifics of what passes, three or four rate hikes in 2018 are plausible.”