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Outlook 2017

Don't Count on 3 Rate Hikes from the Fed

Editor's Note: Kitco News has officially launched its 2017 Outlook where we ask if this is the start of a new Raging Bull market. Be sure to catch all our coverage here, which includes gold forecasts, special technical reports and of course, our popular Invest Like The Experts Series. We will also be launching a new feature so be sure to stay tuned!

(Kitco News) - Dec. 21 – After a 12-month wait, the U.S. Federal Reserve delivered just one interest rate hike in 2016, despite expectations at the start of the year for three or four.

Could 2017 follow that pattern as well? Don't be surprised if unexpected conditions arise that could derail the path toward Fed monetary policy normalization.

  • "The Fed has repeatedly overestimated the strength of the US economy since the 2009 financial crisis. You’d think it would have recognized the pattern by now and trimmed its forecasts, but no." -- Philip Diehl, 35th Director of the U.S. Mint and current President of U.S. Money Reserve. 

  • "Trump will pick a different leader for the Fed as soon as he can. Yellen is part of the old team – he wants a new team." -- Rob Lutts, Cabot Wealth Management

  • "U.S. monetary policy is not operating in a bubble." - Karissa McDonough, People’s United Wealth Management

The Trump Wild Card

The actual impact of Trump fiscal policy may be a wild card for how markets trade in 2017. Financial markets are pricing in expectations for faster economic growth and inflation in 2017, based in part from President-elect Trump's proposals of tax cuts, deregulation and infrastructure spending.

"This massive stimulus package is unlikely to be not offset by spending cuts and higher taxes. After all, a revenue-neutral package wouldn’t provide much stimulus. This would raise deficits, put pressure on the Fed to raise interest rates, and possibly overheat the economy," says Philip Diehl, 35th Director of the U.S. Mint and current President of U.S. Money Reserve. 

It remains to be seen what will actually emerge from the proposals. "Who knows what he’ll actually propose to Congress, or what Congress will approve?" Diehl says.

The $64,000 Question: What Will the Fed Actually Deliver In 2017?

At the latest Fed meeting, Fed Chair Yellen telegraphed intentions to hike interest rates three times in 2017. Not all agree this will happen.

The Fed will not raise rates three times in 2017, Diehl says. "The Fed was able to squeeze modest GDP and employment growth from the economy only by abandoning its interest rate plans for the year. Slow economic growth at home and volatile geopolitical and economic conditions abroad derailed the Fed’s plans for 2016. These conditions will deteriorate in the New Year," Diehl says.
Rob Lutts, CIO of Cabot Wealth Management and author of The Great Game of Business: Investing to Win, expects just one interest rate hike in 2017. "Yellen told us they all expect three in 2017 – most do not believe it," Lutts says.

Factors That Could Derail the Fed

There are a number of potential factors that could derail the best intentions of the Federal Reserve to normalize monetary policy in 2017. These include recession, geopolitics and the BRICS nations.

  1. Recession. The current economic expansion is the third longest since World War II, the U.S. stock market is trading at all-time highs, with overstretched valuations.  
  2. "The wholly unexpected post-election rally has all the markings of irrational exuberance based on unrealistic expectations for Donald Trump’s fiscal policies. If we enter a recession next year, the Fed’s plan for rate hikes will be thrown overboard," Diehl says.

  3. Geopolitics.  Diehl points to rapidly rising instability in Europe, driven by Russian foreign policy, as a factor that could throw a wrench into Fed policy in 2017.
  4. "Putin’s intervention in Syria not only saved his client, Bashar al-Assad, it sent a million refugees fleeing into Europe. The European refugee crisis is not a side effect of Russian intervention in Syria; it is Putin’s strategic objective," Diehl says.

    The Russians will have ample opportunities next year to drive a stake in the heart of a united Europe, Diehl adds. "The fate of the EU probably hangs on the outcome of national elections in France, the Netherlands, and Germany in 2017. Muslim immigration, terrorism, and membership in the EU will dominate these campaigns, and right wing candidates who, like Trump, are friendly to Putin are mounting stiff challenges to mainstream parties."

    Questions about whether the EU will survive still linger. "Putin is in position to help these candidates with cyber-attacks against their political opponents and, if he chooses, by orchestrating terrorist attacks designed to sow fear and undermine confidence in the political establishment. If election results follow patterns set in Britain, the U.S., and Italy this year, the EU may not survive," Diehl says.

  5. The BRICS. Intensifying economic vulnerabilities in China, the Americas, and India could constrain Fed monetary policy as investors seek the safety of dollar-denominated investments, raising the value of the dollar and undermining economic growth in the BRICS, Diehl adds.

Beyond those risks, the Fed has other factors to weigh as well. Aging demographics and a potential increase in protectionist trade policies around the world could constrain GDP growth, McDonough says.

"The Fed is walking a bit of a tightrope.  They may have a greater degree of leeway than before, when they were really the only game in town in terms of healing the economy, but they need to be careful to not normalize for the sake of normalizing – if growth dynamics have not actually changed significantly," McDonough says.

Will Trump Threaten The Fed's Independence?

Another point of contention in 2017 could become be Donald Trump’s reaction to the Fed. "This is a new potential source of volatility that the bond market has not had to contend with in the past, a President-elect’s reaction to the monetary policy being carried out by the Federal Reserve," McDonough says.
"We have not seen direct reaction to the most recent Fed meeting but that does not mean that this is off the table – he has opined on Fed action in the past, McDonough says.
McDonough highlights two points traders may want to consider:

  1. "It has been shown by the data that the Fed must be independent of politics in order to best serve the economy.

  2. A longer term concern might be changes to the Federal Reserve Act which protects the Fed’s independence."

What It Means For Gold

The rising interest rate environment has been negative for gold over the last three months, Lutts says. "I do feel gold will bottom this year and will eventually reflect higher inflation trends over a three to five year period. Gold will sell for over $2,000 an ounce by 2019," Lutts concludes.

By Kira Brecht, Kitco.com

 

 

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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