Tonight sees the FOMC rate decision and anything other than a 25 basis point rate hike will be unacceptable for the market. We have seen a natural degree of calm in the last 24 hours, which is normal ahead of the Fed, but it is rare that we see the probability so nailed on for a hike in the rate, the probability is currently at 98%. A move in December is not uncommon, however, as we have seen a December hike for the last 3 years. There is no doubt that the markets believe the economy is ready for another rate hike in the system, but it will again be a question of the tone of this hike and just what it means for the balance sheet reduction.
The reduction of the Fed balance sheet is something the market has brushed off, as US equity markets remain incredibly strong, however, the progression of the tax reform bill is as equally important to the markets and to the Fed. The Fed’s decision to begin to wind down the balance sheet leaves the economy without a backstop, a backstop that the tax reform bill should go some way to replacing. If the tax bill stalls this could affect the rate of that balance sheet reduction, and after the Doug Jones win in Alabama overnight there is every chance that it will be slowed down. The win in the race for the Alabama Senate seat for Democrat Doug Jones, the first for a Democrat in 25 years, means that the Republican majority in the Senate is now even slimmer at 51-49.
If we get the expected 25 basis point rate hike market, the reaction could well be muted, as this has already been priced into the markets for weeks. The headline act for the markets will be the press conference by Janet Yellen and just what her outlook will be for rates going forward, as well as her take on the current inflation situation, something that hasn’t worried the Fed up until now.
Ahead of the announcement, US equity markets have soared with the Dow trading at yet more record highs. Again an expected result will leave many a little cold, but we should also get a line as to how many rate hikes the Fed expects in 2018. With the continuation of the balance sheet reduction as well as a successful pass of the tax reform plan, there is no reason to think that there will be fewer than 4 rate hikes next year, potentially even more.