December 14, 2015

Rate hike expectations for this week

There's an overwhelming consensus as we approach [this] week's Federal Open Market Committee meeting that the Federal Reserve will hike the federal funds rate for the first time since June 2006. The only thing that remains unclear is the trajectory of any additional rate increases.

The consensus appears to call for two to three additional rate hikes next year, but I disagree. I expect a "one-and-slow" approach (as opposed to my previous expectations of a "one-and-done" hike).

From my perch, the Fed's statement accompanying next week's rate hike should sound fairly dovish, based in part on these factors:

-    The domestic and global economic picture and its foundation are more wobbly than consensus expectations.

-    Deflationary conditions still dominate the landscape.

-    Peak housing and autos likely lie ahead.

-    The U.S. manufacturing base remains frail, and policymakers are fully aware of this.

-    Fragile economic growth exposes the rate-hike trajectory to vulnerability from unexpected events. Policymakers are fully cognizant of this as well.

-    A near bottom in commodities likely lies ahead.

-    Wages have bottomed, too.

-    Growing geopolitical risks can quickly seep into (and reduce) growth expectations.

-    Credit markets have tightened, and delinquencies and defaults are rising. The widening spreads between investment-grade and high-yield bonds have already tightened markets. The widening of CCC/BB credit spread is also really conspicuous and should be worrisome, as it weakens the most-vulnerable companies.

-    We're entering a presidential-election year, so the Fed will probably err on the side of conservatism in its policy.

Of course the $64,000 question is how markets will respond to dovish rhetoric next week.

My answer: I don't know.

On one hand, recognition of a fragile global-growth slope could frighten fundamentally based investors. On the other, a "one-and-slow" approach and a range-bound 10-year Treasury yield could elevate valuations.

But again, unlike many so-called "experts," I'm willing to admit that I just don't know. Unfortunately, much will depend on how the machines and their algorithms interpret the headlines and news.