The US Federal reserve just raised interest rates to 0.75%. This move was largely expected. It is the second time in as many years that the Fed increases the interest rate, but despite making the same move it made a year ago, it seems this rate hike will be the last of its sort. The Fed sees more rate hikes during 2017, accelerating the pace of monetary policy normalization. This is largely due to the fact that President Elect Trump turned the markets on their heads and is vowing to accelerate fiscal expansion.
Fed Trumps the Rally
The Dow Jones took a small tumble after the Fed’s announcement yesterday. Markets had already priced a 2016 rate hike in, but were not entirely aware of the Fed’s plans to raise rates three times next year. This comes just as Trump proposed to boost fiscal spending, a move seen as a clear driver of inflation. The Fed wants to keep inflation at that 2% mark, and it seems that a fiscal expansion might drive it above that level. Proposed Fed hikes next year might cool markets down.
1.5% Interest Rates by the end of 2017?
The potential for 3 interest rate hikes next year will affect money supply in general but may also affect certain sectors of the economy more than others. If every rate hike indeed happens and the Fed hikes by 25 basis points each time, then by the end of 2017 the rates will be at 1.5%. This affects the auto industry and construction directly. Both industries rely on their client’s ability to obtain credit in order to make their sales.
Other markets will suffer
But auto makers, banks and companies involved in construction will not be the only sectors of the market that could see their business affected. Commodities, especially oil, could well see their prices plummet. In fact, WTI already responded to yesterday’s announcement, dropping by more than 3.8%. That is the sharpest drop since the OPEC deal was announced and the price of oil started climbing. With 3 more hikes in 2017, oil could well go back down to the $45 USD range.
Interest rates will strengthen the US Dollar
The prize of oil and other commodities will go down because the US Dollar will strengthen every time the fed hikes the rates. This might also take a bite out of the goals that Trump wants to deliver on. A more expensive US Dollar will encourage more imports, thus taking a bite out of the fiscal expansion. If markets were just celebrating with a Trump rally, now the Fed will make them sober up. Trump and the Fed are poised to make 2017 a year full of surprises.