17 MAR

2017

Although the implied probability of a March rate hike was only 30% during February, it became a near certitude over the past few days. The speech by Janet Yellen in early March and comments from several other Fed members have recently hinted strongly at the rate hike cycle being accelerated. The news therefore comes as no surprise, although it does nonetheless mark a real sea change.

The Fed has stepped-up the pace, from one hike per year, and is now anticipating 3 or even 4 further increases over coming months. This change in pace has been motivated by the abatement of external risks, along with strong job creation data and a rising trend in US inflation. Even though the budgetary stimulus measures promised by Donald Trump remain largely uncertain, inflation is rising sufficiently strongly to justify monetary normalisation.

It is currently difficult to estimate the neutral monetary policy rate. According to the Taylor Rule, the base rate should be close to 3.50%. As the 2.5% spread with the current rate is not tenable, the Fed should therefore increase rates to around 2% within 18 months.

This was the objective implied in the Fed comments which, despite all of the requisite precautions, increased the probability of further rate hikes. These were reassuring comments to justify monetary tightening.

Over the next few months, US monetary normalisation should continue to weigh on US bond performances (particularly among short-dated maturities). Over the longer term, this factor may also weigh on household spending, which only budgetary stimulus measures should prevent from slowing down.  Time for words gives way to time for action.