Fed: Preparations for a new jumbo size rate hike

The Fed will wrap up its two-day policy meeting tomorrow. Before the meeting, market participants are pricing in an 80% probability of 75 basis points and a 20% probability of 100 basis points in the swap market. In this regard, we can consider that the FOMC is preparing to raise interest rates by 7...

The Fed will wrap up its two-day policy meeting tomorrow. Before the meeting, market participants are pricing in an 80% probability of 75 basis points and a 20% probability of 100 basis points in the swap market. In this regard, we can consider that the FOMC is preparing to raise interest rates by 75 basis points, most likely at its July meeting. Scenarios will of course vary according to 75 bps and 100 bps rate hikes. We will be interested in the possibilities of recession in the content of the FOMC statement and Powell speech in a 75 bps movement that does not contain any surprises, and the Fed's action plan on inflation in such an economic recession environment. We will try to analyze the Fed's concern about inflation and the perception of how much it can ignore growth.

 

The FOMC will likely raise interest rates 75 basis points for a second consecutive month in July, raising the fed funds rate to the range of 2.25%-2.5%, which is considered the neutral rate. For guidance on future federal funds rates, we'll look at how the committee has characterized the economy and inflationary pressures. Concerns about the rapid cooling of the housing sector may also support the view of those who expect inflation to drop sharply next year and think that the Fed will start a rate cut in 1Q23. Ultimately, the most important indicator of the Fed's actions will be inflation, in any case.

 

Fed futures funds rate pricing… Source: Bloomberg, CME Fedwatch

 

On the side of the policy statement; The committee will likely acknowledge some slowdown in the economy and could add a reference to the weakness in the housing market. The phrase “Committee expects inflation to return to the 2% target”, which was used in Fed communications, is an article that is not valid for the near term. Powell will likely have to address the recent deceleration of the economy in the 2Q22 GDP framework as well. To what extent can the Fed confirm its commitment to the 2% inflation target in these circumstances? After all, when economic activity is slowing it is harder to be hawkish than when it is strong.

 

The most important lesson learned from former Fed Chairman Arthur Burns' failure to control inflation in the 1970s was that he stopped rate hikes too soon when the economy fell into recession. For this reason, the expectation from the Fed is not to stop the rate hikes, but to slow down the pace of interest rate hikes. During Burns' tenure, the rate of change in the consumer price index was 6% per year in the early 1970s, but rose to over 12% per year in late 1974 after the Arab Oil embargo. Adverse economic events led to multiple oil shocks (1973 and 1979), the Vietnam War, and the government contained heavy government deficits resulting from its programs. Right now, there are post-pandemic supply shocks, the threat of a global recession, and the Russia-Ukraine War.

 

In this context, Powell's inflation assessment will provide important information on what the Fed will do at its next meeting in September. The June CPI report contained an alarming positive surprise in core services categories, where price increases tend to be sticky. We assess that Powell has yet to see evidence that he will need to cut interest rate hike band to 25 basis points, and we think the first point of decline will be the 50 bps band by the September meeting. There will be two new employment and CPI reports before the September meeting. Even if gasoline prices continue to fall, it remains deeply doubtful that core inflation will slow convincingly enough for the Fed to downshift to 25 basis points. Powell is likely to lead the markets to expect a 50 basis point increase at the September meeting.

 

The main fact that we will pay attention to in Powell's speech, and the range that the Fed should pay attention to in policy progress, is: The Fed needs to confirm its determination to break inflation without further frightening the market, which is expecting a pessimistic future. At the same time, the Central Bank's incomplete analysis of inflation forecasting last year should not be repeated this year in terms of growth. The Fed cannot be overly optimistic about growth, given the signals from the weakening economic activity data. Powell is expected to guide markets to expect a 50 basis point rate hike in September. In terms of policy rate, the Fed will end this year in a position above the predicted neutral interest rate.

Kaynak Tera Yatırım
Hibya Haber Ajansı

26 Tem 2022 - 12:30 - Ekonomi



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