Interest rate hikes: Wall Street expects three more in 2016

The Fed is expected to raise interest rates for the first time in nine years this week, and as many as three more times next year, according to a recent survey. 

Markets expect the Fed to hike interest rates this week and as many as three more times next year, according to the CNBC Fed Survey, and respondents believe it's bad for stocks, housing and the economy.

As a result, the 42 respondents, including money managers, economists and strategists, have boosted the probability of a recession in the next year to 22.9 percent, the fifth straight increase and the highest level since 2012.

"No one has successfully gotten off zero," writes Jim Bianco, founder of Bianco Research. "The Japanese tried in 2006 (hike once and then cut). The ECB tried in a 2010 hike (once and then cut to negative). What the Fed is about to do is unprecedented."

"Never before has the Fed initiated a series of rate hikes amid a high-yield spread above 600 bp, a rising default rate, flat to lower profits, sluggish business sales and severe industrial commodity price deflation," said John Lonski, chief economist at Moody's. Fed ChairJanet Yellen is expected to explain the reason for the central bank's decision on Wednesday.

On the plus side, the negative effects of rate hikes are not viewed as being extreme. On a scale of -5 to 5, the overall economic effect average is just -0.2. Bond prices are seen taking the worst of it, with an average -1.2 and housing is next with -0.7. Consumer spending is actually seen benefiting slightly.

"Six years into this economic cycle, ZIRP (zero interest rate policy) is now penalizing savers more than it is rewarding borrowers," said John Augustine, chief investment officer of Huntington National Bank.

Overall, 38 percent of respondents think the process of rate normalization will end badly for the U.S. economy, 44 percent see it as neutral and 13 percent believe it ends well.

While respondents on average see three rate hikes in 2016, they are actually quite divided: a third expects just two, a third expects as many as four and 21 percent look for three. About 60 percent see the next hike after December coming in March. The funds rate is seen hitting just 0.9 percent next year, 1.61 percent in 2017 en route to a terminal rate of 2.6 percent in early 2018, which is lower than the prior survey.

On average, respondents also see the Fed allowing its balance sheet to begin declining at the end of next year.

"One-third of active investors have never seen a rate hike and think it is the end of the world," writes Art Hogan, director of equity research of Wunderlich Securities. "It is not."

Stocks are expected to offer modest returns during the next two years amid Fed rate increases. The S&P is seen closing next year at 2,140, up 5.8 percent from the current level. In 2017, the S&P is seen rising to 2,223, or a 10 percent gain from the current level in two years.

The 10-year Treasury yield is expected to rise to around 2.67 percent next year and nudge above 3 percent in 2017. But respondents overwhelmingly say a rate hike on Wednesday is already baked into the stock and bond markets.

Some are more optimistic on stocks. Writes Scott Wren, global equity strategist of the Wells Fargo Investment Institute: "Nobody is chasing this market as we sit just 4 percent below the all-time record high in the S&P 500. Retail investors are underinvested in stocks and sitting on too much cash."

Wall Street lowered its forecast for GDP, seeing growth of 2.3 percent this year and around 2.4 percent for the next two years. Global economic weakness is by far seen as the biggest threat facing the U.S. economic recovery. Inflation is expected to tick up next year and to finally reach 2.12 percent by the end of 2017, but many don't see much of it and question whether hiking rates without inflation makes sense.