As inflation hits new 40-year highs, expectations for interest rate hikes from the Federal Reserve are also rising. With the Federal Open Market Committee responsible for setting rates due to hold a policy meeting this week, markets are increasing their bets on how things will play out, especially in the months ahead. There’s still about a 2-in-1 chance that this week’s meeting, which ends Wednesday, will see a 50 basis point increase, according to CME Group’s FedWatch tool that measures prices in fed funds futures markets. . But the potential for a 75 basis point move is rising, up 34% on Monday morning from just 3.1% a week ago. The big move came after Friday’s Consumer Price Index report showed inflation in May jumped 8.6% from a year ago, the biggest 12-month gain since December 1981. Markets now see a greater chance that the Fed will move more aggressively, if not now then in the months ahead. FedWatch says the central bank’s benchmark interest rate will now end 2022 in a range of 3.25% to 3.5% from its current target of 0.75% to 1%. There’s even a roughly 44% chance of going a quarter point above that, based on prices around noon ET on Monday. “The US Treasury curve now projects ten Fed rate hikes of 25 basis points by the end of the year,” DoubleLine Capital CEO Jeffrey Gundlach tweeted late Sunday. “There are five Fed meetings before the end of the year (starting with this week). The market’s bloodless verdict is up 50bp in each meeting, unless [Fed Chair Jerome Powell ] puts bigger individual hikes ‘on the table’ before that.” A series of big hikes ahead If the Fed continues on this path, it would represent the most significant tightening since the 2004-2006 cycle, when the President of the Alan Greenspan at the time was trying to slow an economy in the midst of a housing bubble that would eventually burst in 2007. As traders look for a 50 basis point move this week, they have dramatically increased the odds of a rise in 75 basis points in July, now putting that probability at 71% The market then expects 50 basis points in September, 50 more in November, then 25 in December Investors will have a better view of the expectations of Fed officials Wednesday when the central bank releases its revised “dot plot.” is facing an accelerating price environment despite the rapid tightening of the financial situation. conditions,” Citigroup economist Andrew Hollenhorst said in a note. “This should mean an increase in median ‘points’ and inflation forecasts, as well as the possibility of considering larger rate increases of 75 points. base.” “With this price already priced in by the markets, perhaps the most important takeaway is whether the President [Jerome] Powell remains committed to tightening financial conditions and curbing inflation, even though the necessary tightening is increasingly likely to lead to a recession rather than a ‘soft’ landing,” he added. The market has done some of the Fed’s work Stocks and bonds have Markets fear that if price expectations break loose, it could lead to even more Fed tightening and an end to stimulus policies. easy money that helped propel the market from the darkest days of the financial crisis in 2008. “There’s a tremendous tightening in financial conditions,” said Joseph LaVorgna, a Wall Street veteran and chief economist of the National Economic Council under former President Donald Trump. “The housing market is closing, the stock market is imploding, credit spreads are widening and the dollar is strengthening. “Inflation is a reta rde,” he continued. “If I were the Fed I would be talking about the fact that my economy is fundamentally weak, the Fed is very conscious of inflation. There is tremendous demand destruction as a result of this significant tightening of financial conditions.” But LaVorgna expects the Fed, and in particular Powell at his post-meeting press conference, to react to market prices and continue to hike rates aggressively. “The Fed needs to talk less about what it’s going to do and [talk] more about how tighter financial conditions are going to do a lot of its work for her,” he said. “That’s what the Fed should be doing. For me, the Fed is going to make a classic policy mistake by staring monetary policy in the rearview mirror.” Financial conditions judged by a Chicago Fed gauge are at their tightest levels since May 2020, when the pandemic began. The Fed hopes to use its rate hikes plus balance sheet reduction to tighten conditions and slow the economy, but officials said there is still work to do before that target is met. on everything the Fed has done for the past 15 years, but they can’t do that,” LaVorgna said. “They’re stuck on this path to transparency.
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