Wall Street To Fed: Not So Fast; Dealers See Only Two Hikes In 2017

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New York: Wall Street's top banks were not immediately swayed Wednesday by signals from the Federal Reserve that the pace of interest rate hikes could pick up significantly next year, sticking instead to a view that the U.S. central bank will lift borrowing costs no more than twice in 2017, according to a Reuters poll.

The poll of primary dealers - the 23 banks that do business directly with the Fed - also showed that a majority of the participants expect U.S. President-elect Donald Trump's economic plans to boost business investment, a notably absent factor in the current economic expansion.

The Fed on Wednesday raised interest rates by a quarter point, only its second rate hike since the Great Recession and a year since the previous increase. Policy makers signalled as many as three increases in 2017 as the Trump administration takes over with promises to boost growth through tax cuts, spending and deregulation.

The Fed's decision, regarded as a virtual certainty by financial markets in the wake of a string of generally strong economic reports, raised the target federal funds rate 25 basis points to between 0.50 percent and 0.75 percent.

"It's a little bit more hawkish than expected. They moved up the dots a little bit more aggressively in the near term," said Aaron Kohli, interest rate strategist at BMO Capital Markets, in New York.

Short-term U.S. interest rates futures implied traders saw a 78 percent chance the Fed would raise interest rates at least once by June 2017, compared with a 63 percent chance late on Tuesday, according to CME Group's FedWatch.

Futures signalled that traders believe it was basically a coin flip the Fed would increase rates at least three times a year from now.

Wall Street banks, however, were not raising their own estimates for future hikes just yet, and none of them see another increase before the second quarter of 2017.

The 18 primary dealers who participated in the poll forecast the federal funds rate midpoint at the end of the second quarter to rise to 0.88 percent and to 1.13 percent by year end. That forecast was unchanged from a Reuters poll conducted in early October and compares with the FOMC's own projection of 1.13 percent.

"This (statement) feels like we are going to get some more rate hikes next year with possible fiscal stimulus coming down the pipe. But we just don't know what they are. We have no details," said Justin Lederer, Treasury strategist at Cantor Fitzgerald in New York.

The pace of rate hikes could accelerate next year, with a median forecast among 16 respondents for the rate to reach 1.76 percent by the end of 2018.

Poll participants did, however, estimate close to a 50 percent chance that the pace of hikes from here could proceed at a faster rate than currently anticipated.

Turning to the implementation of Trump's economic agenda, 12 of 15 dealers see his still-to-be-defined stimulus plans as likely to boost or significantly boost U.S. business investment.

Trump's still-evolving trade policies, meanwhile, stand out as the greatest risk to the outlook in the eyes of the primary dealers. Nine of 17 said they viewed trade policy as a potential headwind, while five cited fiscal policy as the biggest risk and another two said a stronger dollar could up-end the outlook.