Asset managers are widely anticipating a US interest rate increase to be announced by the Federal Reserve, but expect chair Janet Yellen to "disappoint" markets with a dovish outlook in the face of President-Elect Donald Trump's expansionary fiscal policy plans.
Following a two-day meeting of the Federal Open Market Committee (FOMC), the Federal Reserve is expected to announce an increase in the target range for its federal funds rate to between 0.5% and 0.75% later today, up from 0.25% to 0.5%.
The move would come a full year on from the Fed's last rate hike in December 2015 - its first for over a decade - and has already been widely priced into markets, with federal funds futures implying a 100% probability of a rate rise since 21 November, up from 75% before the US election.
Despite the likelihood of a marginal increase, many eyes will be on Fed chairman Janet Yellen's (pictured) subsequent press conference. Commentators have already argued that Yellen will want to take a measured approach when addressing markets following Donald Trump's presidential victory last month to avoid criticism previously targeted at Bank of England governor Mark Carney over a number of policy measures he took in the wake of June's Brexit vote.
As a result, the Fed is not expected to alter its economic forecasts or predictions for interest rates over the next three years, according to economists, with two rate hikes currently pencilled in for 2017.
David Kohl, chief currency strategist at Julius Baer said the uptick in sentiment around a rate rise since November can be "entirely attributed" to the discounting of Trump's upcoming expansionary fiscal policy by markets.
He said: "We very much agree with the market's expectations as various Fed members, including Fed chair Yellen, have prepared markets for a rate hike over the past weeks, and the robust US economy as well as confident US financial markets could easily digest a rate hike.
"We expect the Fed assessment of the upcoming reorientation of fiscal policy under Trump to be the most interesting and the most important part of the FOMC meeting. The lack of details on possible infrastructure spending programs or intended tax cuts will discourage the Fed from telegraphing its reaction to the more expansionary fiscal policy already at this meeting. But the general message that looser fiscal policy allows for a tighter monetary policy will be difficult to avoid."
Kohl added most FOMC members' expectation of two additional rate hikes next year seems "appropriate" and will be supportive of the US dollar. However, he added the Fed may want to wait before pursuing a more aggressive rate-hiking approach due to uncertainty around the implementation of proposed tax cuts or expenditure programmes.
"The appreciation of the US dollar and the increase in bond yields and mortgage rates is another reason to prefer a careful assessment," he said.
"Stockmarkets are expected to take the rate increase favourably. In contrast to December last year, when a Fed rate hike was followed by an equity sell-off, we expect a rather positive reaction this time.
"The good cyclical backdrop is the major reason for this differentiation and a powerful motivation to take higher rates as a confirmation for a solid growth backdrop and not as a threat to it."
More hikes in 2017
Likewise, David Shairp, head of manager oversight at Prudential Portfolio Management Group, said this week's expected rate rise could be followed by several more, going as far as to suggest this could lead to a "mini replay" of the US central bank's 1994 rate rise, which was quickly followed by five more hikes, as the market underestimated the extent to which the Fed had fallen behind the curve.
"Interestingly, at the time of the hike (February 1994), the gap between two-year treasury yields and Fed funds was [around] 120bps - suggesting the Fed was that much behind the curve - compared to 65bps now. This reflects the degree of tightening priced in for 2017 (i.e. one and a half hikes)," he said.
"However, accelerating global activity plus evidence of accelerating inflation could lead to a scenario where markets begin to discount a Fed that is behind the curve. While this is a risk scenario at this stage - formally we look for two hikes in 2017 - it bears monitoring."
Richard Turnill, global chief investment strategist at BlackRock, and Jim Kochan, a fixed-income strategist with Wells Fargo Asset Management also forecast further rate hikes in 2017 following action this week.
Turnill said while markets will be eyeing clues as to how many moves may follow in 2017, the company currently expects two rises next year. "This week's flash PMI data should confirm a broad pick-up in global activity," he said.
Meanwhile, Kochan said while the Fed is likely to continue the process of raising the short-term federal funds rate from its "abnormally low level", it will want to do so slowly as doing it too quickly could lead to a stronger dollar, creating a headwind for exporters and spillover problems for emerging markets that have dollar-denominated debt.
"A gradual, limited rise in the federal funds rate and continued moderate US economic growth could attenuate investor fears that emerged after the election," he said. "To the extent that the Fed acts in response to improved economic growth, the case for credit could be strengthened."