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Fed to Stick to 75 bps Hike in July

With interest rates expected to rise another 75 basis points (bps) next week, Fed Chair Jerome Powell will likely slow the pace of interest rate increases and front-load policy with another increase in July. Economists surveyed by Bloomberg expect the Fed to hike rates by a half percentage point in September and another quarter-point hike in each of the last two meetings of the year. If all this is realized, the federal funds rate will be above 3% by the end of 2022, which would be the highest level since early 2008.

Earlier this month, the Atlanta Fed’s Raphael Bostic said that a full percentage point hike may be too much for many people to take. However, market participants took note of his remarks. On the other hand, the latest poll showed a forty percent probability of a U.S. recession within the next year and a 50% chance of one in two years. While these numbers are not conclusive, they do indicate that policymakers are keeping a close eye on the bigger picture.

Another important report this week will be the Summary of Economic Projections from the Federal Open Market Committee. The document updates expectations for a range of economic measures, including inflation, unemployment, and the federal funds rate. It also summarizes the path the Fed’s policy is expected to take over the next two years. For this report, the odds of two 75-bp hikes in July are now at 87.7%, a large increase from zero last week.

The latest announcement from Powell comes at a critical time for investors as it indicates the Fed’s stance on the rate hike process. While it’s not certain whether the Fed will hike rates by that much, it does signal that they will stick to a policy of gradual increases over the next two years. Powell also highlighted that he doesn’t expect a 75-bps hike to become common. Powell’s comments were accompanied by formal remarks in which he highlighted the problems faced by lower-income Americans and stressed the need to reduce uncertainty surrounding key economic reports.

After the May inflation report, some economists are betting that the Federal Reserve will raise interest rates this month. This would help curb runaway consumer prices. But at the same time, traders are pricing in an 80% chance of a half-point hike during the June meeting. The other twenty percent of traders think the Fed will move aggressively and opt for a 75-bps hike, which would be its first since 1994.

The recent inflation report was hotter than anticipated, indicating that inflationary pressures in the economy remain strong. Bond yields increased after the report, adding fuel to fears that the Fed may be on the verge of action. After the May report, five officials now expect a 75-bps hike in July. A 5% hike by 2023 will push the Fed’s target rate to 4%.

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