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Fed sets strong tightening ambitions for 2017

While the rate hike was a given, the fact that the Fed forecasts at least three more hikes in 2017 is somewhat a surprise.

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The reaction was immediately felt on bond yields and the US dollar moving higher. Equities moved lower as the higher yields were not accompanied by higher inflation, thus is seen purely as financial tightening.

Can the Fed stick to the plan this time?

Last year, as the Fed hiked for the first time since the financial crisis, expectations were high for further rate hikes, but as other central banks remained globally accommodative and inflation was subdued, the Fed continuously pushed back the deadline. However, there are some important distinction to take into consideration this time around. First, we will start the year with a complete change of government, and a president elect who intends to implement a large scale fiscal stimulus plan. Second, oil prices may continue to be supported upwards, after a first coordinated output cut by both OPEC and Non-OPEC members since 2001. Third, copper, iron ore and other industrial commodities have reversed a multiyear downtrend. Fourth, US wages are starting to rise, after having being under pressure for several years.

This should all contribute to higher inflation, which may be the missing piece to convince the Fed to continue on its tightening path. It work in favor of the greenback, which we expect to gain another 10% versus the Euro and the Franc over the course of next year. While a higher cost of capital is initially seen as negative for equities, rising yields will also allow banks to increase their lending activity, in turn increasing the capital availability. Lower capital cost to the detriment of capital availability has been an issue that more and more central banks are starting to address. The BoJ and ECB have both recently implemented measures to steepen the yield curve, which longer term is positive for equity markets.

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