Investing.com – Although Morgan Stanley reiterated its expectations that the Federal Reserve (Fed) will only tighten monetary policy twice in 2017, it admitted that a series of factors could bring a rate hike forward to as early as March.
In a note to clients, theses economists maintained their disagreement with the Fed’s median outlook for three rate hikes this year, repeating that they believe tightening will arrive in September and December.
Financial markets, however, while agreeing with the call for only two hikes, currently price in the first to arrive in June, with a probability of 68.5%, according to Investing.com's Fed Rate Monitor Tool.
What would it take for the Fed to hike rates as early as March?
In any case, Morgan Stanley examined the question of what it would take for the Fed to move as early as March in what would be just the second meeting of 2017.
“Higher readings on core PCE (personal consumption expenditures) inflation and a meaningful undershoot of NAIRU (non-accelerating inflation rate of unemployment) could lead to a shift in the Fed's reaction function to one that is less willing to let pressures build before taking rates another step higher,” they said.
These strategists pointed to the fact that the Fed’s assessment of a jobless rate that does not accelerate inflation was 4.8% and that they believed this is where unemployment would remain in the near term.
“If we are wrong and the unemployment rate falls materially below NAIRU, the Fed might be led to consider pulling the rate hike forward,” they said.
In their consideration, the biggest risk for this to happen would be that the surge in business confidence since the presidential election could translate sooner into increased hiring in an already late-cycle, tighter labor market, sending the unemployment rate well below the expected level.
These experts recommended keeping an eye on the jobless rate in the next two employment reports released before the March 15 policy decision.
They also mentioned that core PCE inflation had weakened in November and that their expectations were for price increases to remain under pressure into the spring.
“If we are wrong and core PCE instead firms early enough in the year, coupled with upside risks to growth from fiscal policy alongside the lower unemployment rate, it could lead the Fed to an earlier hike,” these economists admitted.
Morgan Stanley suggested that an escalation in the timing of fiscal stimulus could be the factor that would shift their expectations for the current path of both unemployment and inflation and signaled Trump’s January 20 inauguration speech as the event to watch in terms of setting the tone for how smoothly the administration will be able to work with Congress to enact key pieces of his plan.
In addition to keeping an eye on developments surrounding Congress’ approval of Trump’s fiscal policies and upcoming employment reports, Morgan Stanley also noted that there will be two further readings of PCE core inflation with the second scheduled for release on March 1.
Markets currently put the odds of a Fed rate hike on March 15 at just 22.9%.