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U.S. Interest Rate Hike

During the last Federal Reserve System meeting of 2016, Janet Yellen has announced an increase to interest rates in the United States by 0.25%. As it stands, interest rates in the U.S. are at 0.75% but the Federal Reserve has signaled for approximately three more rate hikes in 2017. The decision to modestly increase rates comes because economic slack in the U.S. has diminished, unemployment is low, and inflation expectations are starting to edge higher. Another added benefit to this was that the stock market had priced in a 100% probability of a rate hike which is extremely important since it signals that the market is in line with expectations.

Although this certainly signals strength and resiliency in the American economy, future rate hikes are not written in stone and will be contingent on how the markets perform during the course of 2017. Of course, markets will react to the appointment of Donald Trump and we need to see if the U.S. will be able to generate their inflation target that will warrant the additional rate hikes next year. During his campaign, Trump did suggest that interest rates were too low but it remains to be seen if he will continue to increase rates given the fact that he is promising heavy stimulus which benefits from a lower cost of borrowing.

It is important to analyze how this scenario will impact Canadians. Historically, the U.S. and Canada have monetary policy that mirror each other however Canada is in a very different position than our neighbours to the south. A rate increase in Canada should technically follow, but this will probably not be the case for 2017. This is all part of a global phenomenon taking place which is known as divergence. On one end, you have the U.S. increasing interest rates after years of having them at near zero, while on the other end of the spectrum you have negative interest rates in Europe. In order for Canada to consider raising interest rates, they must balance economic growth with a higher level of employment. Until Canada sees better economic numbers and inflation to warrant a rate hike, I suspect Canadian interest rates will remain lower for the foreseeable future.

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