What Dec Rate Hike Means For ETFs

October 12, 2017

The Federal Reserve will hike rates in December. That's according to futures markets, which are currently predicting an 80% probability of a rate hike during the final Fed meeting of the year, a sharp increase from only a month ago, when the chance of an increase was closer to 20%.

If it occurs, a rate hike in December would mark the third time the Fed raised its benchmark overnight Federal Funds rate in 2017, and the fourth time it did so since December of last year.

What's caused the big uptick in interest rate expectations, and what does it mean for investors?

Traders Are Fickle

According to Brian Jacobsen, chief portfolio strategist at Wells Fargo Assets Management, it comes down to this: "Traders are fickle."

As large as the recent upswing in Fed rate hike expectations have been, it's not necessarily something investors should be paying too much attention to, he says.

Futures market probabilities "are probably a poor guide to what investors are really thinking and more reflective of how traders are feeling," he explained. "Objectively, the probabilities should be close to 80%. Subjectively, based on the whims of risk aversion, you can see these probabilities move all over the place."

"The fact is that the data support the notion that inflation is slowly moving toward the Fed’s target" and "the economic data has been pretty resilient, if not robust," Jacobsen noted.

Robust Economic Growth

Indeed, as Jacobsen points out, recent economic data releases have been strong, and that may be an understatement.

Earlier this month, the Institute for Supply Management (ISM) reported that its manufacturing PMI jumped to 60.8 in September, the loftiest level since 2004.

At the same time, the ISM nonmanufacturing index climbed to 59.8 during the month, the best reading since 2005.

Even September's nonfarm payrolls report, which was considered a downer by some because it showed the first contraction in jobs since 2010, also contained great news on the economy.

The unemployment rate fell to the lowest point since 2001, and average hourly earnings grew by 2.9% year-over-year, the fastest pace in eight years―both signs of a robust economy that may be accelerating.

Hawkish Fed

Along with strengthening economic data, some hawkish comments from key Fed officials may also be supporting the case for a December rate hike.

In a speech from late last month, Fed Chair Janet Yellen said a gradual tightening of monetary policy was required to prevent the economy from becoming overheated, "potentially creating an inflationary problem down the road."

We should be wary of moving "too gradually" when it comes to interest rate hikes, she warns―which some market observers interpreted as a signal for a December rate hike.


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