Market Overview

8 Reasons Traders Are Preparing For A Rate Increase

8 Reasons Traders Are Preparing For A Rate Increase

The U.S. Federal Reserve is approaching its final meeting of the year, and that means markets are buzzing with speculation as to whether the bank is planning to raise interest rates.

The past year has been punctuated with monthly debates over the merits of a rate hike, something the bank has held off from amid concerns about global instability and inflation. However, the lead-up to December's meeting has brought about even more speculation than usual because the bank's rhetoric so far this year has indicated that a rate increase was coming before the end of the year.

While nothing can be certain until the bank announces its decision on December 16, markets appear to be confident that a hike is on the table.

Here's a look at eight reasons why the bank may raise rates in December.

Related Link: EXCLUSIVE: Mohamed El-Erian Says Fed Signals "Greater Comfort" With Potential December Hike

1. GDP Figures Not As Weak As They Appeared

While the Fed hasn't explicitly said it will use GDP reports in order to make interest rate decisions, the strength of the U.S. economy is an important factor that will drive other metrics like inflation and employment, which the bank says will play a role in its rate hike plans.

On October 29, markets received a first look at how the U.S. economy performed in the third quarter. The figures showed that GDP increased by 1.5 percent, a decline from the 3.9 percent reported during the second quarter.

On November 24, that figure was revised higher to 2.1 percent, though it still represented a drop from the previous quarter's results.

While the lower growth may appear to be an argument for the bank to pause on its tightening plans, analysts said the dip is likely to be short-lived. Many U.S. firms were plagued by high inventories, and they worked to trim their stockpiles during the third quarter. Not only that, but a more in-depth look at the GDP report revealed that business spending on equipment rose, a positive indicator for future growth and stability. For that reason, most are expecting to see stronger growth come the fourth quarter.

2. Inflation Seen Rising

Perhaps the most telling signal as to whether the Fed will raise interest rates is inflation.

The bank has been careful to hold off until inflation appears to be on track to meet its 2 percent target, but predictions about where inflation rates are headed have been varied. On Wednesday, November 26, PCE inflation data (the Fed's preferred measure of U.S. inflation) was released.

If that figure meets or exceeds expectations, the bank is likely to raise rates, but any downside surprises are likely to weigh on the bank's decision.

Most analysts believe the figure will show a slight increase to 1.4 percent. While 1.4 percent inflation still falls short of the Fed's goals, the bank has said that its predictions show inflation is on track to rise to 2 percent in the months to come.

Fed Chair Janet Yellen promised caution when she took over at the head of the bank, but she has also indicated that she would be willing to raise rates before inflation reaches 2 percent – if she felt confident that the measure was headed in that direction.

Related Link: RBC Says Stick With Infrastructure Stocks Until The Fed Raises Rates

3. Strength In The Job Market

Earlier in November, data showed that the U.S. economy added 271,000 jobs in October, which beat forecasts that saw just 177,000 new jobs being added.

The report also showed the U.S. unemployment rate had fallen to 5 percent in October, down from 5.1 percent in September. That figure marks the nation's lowest unemployment level since April 2008, a promising sign for the job market and a good reason for the bank to increase rates.

The October jobs data is likely to play a huge role in the Fed's rate hike decision, as Fed Chair Janet Yellen has been adamant about waiting until the job market improves before increasing interest rates. An unemployment rate of 5 percent is widely considered to be consistent with full employment.

November's jobs data is set to be released at the beginning of December, shortly before the bank holds its policy meeting, but barring any significant downside surprises, most expect the October figures will be enough to push the bank toward a rate increase.

4. John Williams' Comments

San Francisco Federal Reserve President John Williams shared comments mid-November, implying that the bank is likely to raise rates in December. Williams commented that labor data has been particularly encouraging and that there is a "strong case" for a December rate hike.

Though he said the final decision would hinge on data out in the week before the meeting, he appeared optimistic about the possibility of a rate increase. Williams also reiterated the bank's plans to raise rates slowly so as to keep markets calm, something many took as an effort to prepare investors for what's to come.

While this is not the first time a Fed official has publicly spoken about the bank's readiness for a rate hike, markets took Williams' comments as an indication that the bank would raise rates as long as there were no major surprises in the week leading up to the meeting.

5. The Financial Crisis Has Ended

Back in 2008, the United States was falling into dire straits, as the housing market collapsed that the economy declined sharply. The job market was in tatters and banks around the country were beginning to fail, all of which resulted in a recession that wreaked havoc on share markets.

During that period, the Fed lowered interest rates in order to get the nation back on its feet and help kick-start the economy. While the nation's journey back to stability has been both uncertain and slow, most agree that the financial crisis is now firmly in the rearview mirror.

With that in mind, many analysts argue that the Fed should be moving along at the same pace and departing from crisis-level interest rates. With banks and the job market both stable, many believe that now is the time for a rate hike.

6. Most Analysts Are Predicting A Rate Rise

Rate hike forecasts have been a dime-a-dozen this year, as financial analysts struggled to piece together the Fed's policy statements and economic data to form a roadmap accurately predicting where the bank is heading.

However, with just a few weeks to go before the bank is set to meet, the majority of financial firms see a December rate hike as likely. In October, around 63 percent of the economists surveyed by Bloomberg were expecting a December rate increase, but in the month that followed, many more have shifted their predictions to show the bank making a move in December as well.

On November 17, the Bloomberg survey showed 88 percent of the economists surveyed were expecting the bank to move in December. Seven (7) percent said a March increase was likely, and 1 percent said the bank will raise rates in April.

Related Link: Investors Are Pouring Into Bank ETFs Ahead Of Fed Meeting

7. Yellen's Rhetoric

Fed Chair Janet Yellen's rhetoric in the weeks leading up to the bank's December meeting has also been indicative of a rate increase. On November 4, Yellen testified before Congress saying that she saw the nation's economic performance continuing to improve and that acting in December was a "live possibility."

Yellen has always been careful to finish her public comments by saying nothing is certain yet, but she has also insisted that the decision will be data-driven. With that in mind, most analysts have taken the nation's recent strong economic data as an indicator of a sooner-rather-than-later rate increase.

8. Fed Policy Statements

While the Federal Reserve's policy statement has given investors very little to go on regarding the timing of a rate increase, the bank's decision to drop the word "patient" from its March statement lit markets up with speculation that the rise would come before the end of the year. In October, the bank specifically mentioned its December meeting as a possible date for a rate increase, leading many to believe that the bank had plans to raise rates in December as long as no new economic data suggested it do otherwise.

With the majority of the United States' most recent economic indicators painting a stable picture of the future, most economists believe the Fed has no reason to deter from its October plans.

[Editor's Note: PCE data were released Wednesday, November 26; due to the holiday weekend, data analysis is still coming in.]

Posted-In: Bloomberg Janet Yellen John WilliamsTop Stories Economics Federal Reserve Markets Best of Benzinga


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