In the Semi-annual Monetary Policy Report submitted to Congress and the U.S. House of Representatives, Federal Reserve (Fed) Chairman Janet Yellen hinted that “several” interest rate hikes would be increasingly likely in 2017.
A more hawkish Fed
The rhetoric adopted in Yellen’s testimony is notably more hawkish compared to the Fed’s tone in the last few months, which leads us to believe that the Fed could be bringing interest rates up as soon as March. Yellen suggested that “waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession.” [1]
Indeed, with the U.S. seeing an apparent sustained growth pattern, there are convincing reasons for the Fed to move interest rates upward soon.
First and foremost, the U.S. job market has seen sustained upward momentum. The unemployment rate has remained below the 5% threshold for nine consecutive months, in line with the longer-run normal rate of 4.9% expected by Fed officials (see Chart 1). While the average hours of work has dipped a little and averaged 34.4 hours in January (compared to 34.6 hours a year ago), the private sector’s average weekly earnings went up by 3.8% YoY during the same period, suggesting that hourly wages have also increased. In addition, despite a higher comparable base, employment continued to increase by 170,000 per month over the last three months. These trends reaffirm our view that the labour market is setting foot on solid ground.
At the same time, inflation has been clawing up steadily, with the CPI breaking the 2% mark for the first time in over two years in December 2016 (see Chart 2). Looking at different components, prices of housing and transportation expenses have been on the rise and grew 3.1% YoY and 4.8% YoY in January, respectively. These movements, along with the aforementioned labour market trends, provide more support for future rate hikes.
Conclusion
As shown in the implied probabilities of futures’ pricing, there is a 75% chance that the Fed will be raising rates by the end of the first half (see Table 1). Despite the expectation that rates will move up more quickly than in the last couple of years (with a 72.8% chance that interest rates will be brought up at least twice by the end of this year), there seems to be no pressing need for banks in Hong Kong to follow suit.
For now, we are sticking to our expectation of two rate hikes in 2017. As such, considering that the aggregate balance of the banking system has remained largely unchanged since the rate hike in December, the pressure of driving interest rates upward should remain negligible in the near term due to abundant liquidity (see Chart 3). Therefore, the cost of borrowing should remain contained in the near term.
[1] Yellen, J. L. (14 February 2017) Testimony.
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