Will Janet Yellen take away Trump s punch bowl

After what feels like an eternity, the most important Fed meeting of the year is upon us. The Fed Fund Futures market is pricing in a 92% chance of a 25 basis point rate hike at 1900 GMT. Yellen will also deliver her final press conference of the year.

While the actual rate hike is virtually a given at this stage, it will be the Fed’s ‘Dot Plot’ with expectations of where rates can go next, along with Yellen’s press conference after the decision, that could trigger the most volatility of the night.

The key things to look out for:

• The ‘Dot Plot’: back in September the majority of FOMC members saw rates just above 1.1% by the end of 2017, which would be just over one rate hike for the whole of 2017. However, post Trump and his fiscal stimulus plan, we expect FOMC members to raise their forecasts to at least three rate increases next year.
• Rate expectations for 2018: we would also expect the FOMC to revise up their expectations for rates in 2018, in September the majority of members saw rates ending 2018 just under 2%. There is a chance that post Trump we may see a revision back towards 3%, if the President-elect’s fiscal stimulus plans are enough to convince Fed members that growth and inflation will rise sharply in the next couple of years.
• How the market reacts: Right now there is only a 20% chance of US rates ending 2017 at 1.5% (according to Fed Fund Futures), this could rise sharply if the Dot Plot shows an upward revision to Fed members’ rate expectations, and could feed into a major market reaction, see more below.
• Donald Trump’s reaction: Watch Donald Trump’s twitter activity after the Fed meeting. If Janet Yellen threatens to take away the punch bowl at his growth party could he throw his toys out of the pram, and tweet his displeasure? If he does, then this could cause major volatility in financial markets, and it could also be bad news for stocks, as it is likely to lead to questions about the Fed’s independence from Presidential meddling in the coming years.
• No twitter activity from Trump: on the other hand, if Trump can keep himself away from his Twitter account this evening then this would send a positive message to the markets that he will respect the Fed’s independence going forward, which could be seen as positive for markets.
• Watch the Banks: One area where Yellen and Trump could clash is the Volcker Rule. This is one of the most controversial elements of Dodd-Frank regulation, which essentially bans banks from proprietary trading, and Donald Trump hates it. When she was nominated to the post of Fed chair, Yellen supported the rule. During her press conference she may be asked what she thinks of Trump’s plans to scrap certain elements of US financial regulation under his Presidency, how she reacts could be crucial for the markets. If it looks like she would oppose any action by Trump to loosen market regulation then the US banking sector’s rally could come to an abrupt halt. We put this risk at about 20%: unlikely, but high risk if it happens.

Potential market reactions:

• A hawkish Fed: the dollar is likely to surge, USDJPY could get back towards 1.20 in the days after the meeting, and EURUSD could fall below 1.05 and back towards parity. We would expect to see a large move higher in US 10-year Treasury yields, and a steepening of the yield curve. We could see 10-year yields close the year at 2.6%, which would underpin dollar strength into 2017. Stocks may suffer, however, especially if any comments about regulation hurt the banking sector.
• A less hawkish Fed: we would expect to see a continuation of the dollar retreat of late. Any sharp drop in US yields could make it harder for the dollar to recover into year-end. We would expect to see another leg higher in the US stock market, as risky assets cheer a low rate environment for another year.

Ahead of the meeting the dollar is stalling and US Treasury yields are fading, but could this be ‘selling the rumour, buy the fact’? Watch Yellen, and Donald Trump’s twitter account later this evening to find out.