Expecting More 2017 Hikes than the Market

Markets will be grappling with a tightening labor market, rising inflation, and, not least, a new administration.

December 15, 2016


This sector report is excerpted from the Fourth Quarter 2016 Fixed-Income Outlook.

U.S. real gross domestic product (GDP) grew by 3.2 percent in the third quarter, according to the second reading, up from 1.4 percent in the second quarter. We expect output to rise by around 2 percent on average in coming quarters, a bit faster than the trend rate over the past year, as drags from past dollar strength and an inventory adjustment cycle fade. The policy outlook has become more uncertain with the election, though early indications that fiscal easing will be prioritized in the new administration suggest that the risks to real GDP growth in 2017 and 2018 are now skewed to the upside.

Labor Force Growth Is Accelerating as the Labor Market Tightens

The U.S. labor market continues to strengthen, as seen in the impressive growth in the size of the labor force. In the year through November, the labor force participation rate increased by 0.2 percentage point while the unemployment rate declined by 0.4 percentage point.

Labor Force Growth Is Accelerating as the Labor Market Tightens

Source: Guggenheim Investments, Haver Analytics, Bureau of Labor Statistics. Data as of 12.13.2016.

The labor market continues to strengthen, as seen in the impressive growth in the size of the labor force. In the year through November, the labor force participation rate increased by 0.2 percentage point while the unemployment rate declined by 0.4 percentage point to 4.6 percent. The cyclical rise in participation, itself a response to a tighter labor market, is all the more noteworthy given that the structural participation rate is falling by about 0.25 percentage point per year due to the aging U.S. workforce. This rise in participation helped slow the drop in the unemployment rate and the pace of Fed rate hikes in 2016.

Past declines in energy prices have suppressed headline inflation, but the energy drag is set to reverse over the next six months as base effects kick in. Incorporating our updated oil price model, we project that headline CPI inflation will rise from 1.6 percent in October to 2.5 percent in the first quarter of 2017 before falling back toward 2 percent.

We expect Fed policymakers to follow their recent rate increases with three, and possibly four, more hikes in 2017. While this would be faster than markets are now pricing in, it would still leave rates below levels prescribed by standard policy rules. President-elect Trump will have an opportunity to fill two open seats on the Board of Governors, though this should not affect Fed policy in the near term.

Meanwhile, monetary policy divergence will continue to support the U.S. dollar. The ECB has extended quantitative easing (QE) at a pace of €60 billion per month through at least the end of 2017, while the BoJ is far from reducing stimulus. In our view, their QE programs continue to buttress global sovereign debt and credit markets.

Our Oil Model Indicates Inflation Is on Target to Hit 2.5%

Incorporating our updated oil price model, we project that headline CPI inflation will rise from 1.6 percent in October to 2.5 percent in the first quarter of 2017.

Our Oil Model Indicates Inflation Is on Target to Hit 2.5%25

Source: Guggenheim Investments, Bloomberg, IHS Markit. Data as of 12.2.2016.

—Brian Smedley, Head of Macroeconomic and Investment Research; Maria Giraldo, CFA, Vice President

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. ©2016, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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