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The Fed Is Bluffing - Outside View by Asad Dossani

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The Fed Is Bluffing
Feb 15, 2017

How many times will the Fed hike rates this year? Janet Yellen, the Fed chair, testified before the US congress yesterday. She stressed the importance of hiking rates soon. Of not delaying monetary tightening.

Federal funds futures are pricing in a 77% chance of at least two rate hikes by year end. And a 43% chance of at least three rate hikes. All signs point to higher interest rates by this time next year.

But let's take another look. Interest rate increases are very different from decreases. At the first sign of any crisis or problem, interest rates are lowered without warning.

But rate increases are another story. Markets must be told in advance. Given adequate time to prepare. Everything must be just right.

In other words, the Fed is quick to lower rates but slow to raise them. They'd rather err on the side of rates being too low. Rates that are too low could lead to inflation. Rates that are too high could cause a recession. Clearly, they feel recessions are much worse than inflation.

We can conclude that the Fed is only going to raise rates three times if everything goes right. But there is no guarantee of this. With all the political uncertainty in the US, things could just as easily go wrong. President Trump is slowly learning that politics takes time. Getting legislation passed is a painstaking process. There are lawmakers, courts, voters. All of whom have a say.

Here's what's going to happen. All the factors propelling the Trump bump over the last two months will be watered down. Things won't change too much. Markets will come back down to earth. Inflation won't be too high.

And the Fed won't raise rates three times. They'll raise them once for sure, just to save face. Maybe even twice. But three times isn't on the cards.

In December 2015, the Fed raised interest rates for the first time since the financial crisis. They said they'd raise rates three times in 2016. Markets priced that in.

But the reality was different. The Fed raised rates only once. And that too, at the last possible moment.

Remember that interest rate hikes take much longer than cuts. They only occur if all the stars align. And what are the chances of that?

Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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