Fed rate hike preview: Markets fully pricing in 75 basis points

The US Federal Reserve is widely expected to lay down an outsized 75 basis point rate hike on Thursday after US inflation accelerated to a 40-year high in May.

The inflation data, which was released last Friday, has drastically pushed forward the Fed's interest rate expectations.

CME's Fedwatch tool predicts a 95.6% probability of a 75 bps rate hike and a 4.4% likelihood for 100 bps.

A week ago, it was expecting a 96.1% probability for 50 bps and 3.9% for 75 bps.

Target rate probabilities for 15 June 2022 Fed meeting (Source: CME Group)

JP Morgan breaks it down

Three quick views from JP Morgan:

• 50 bps: "This would be market-negative and may represent the worst case scenario"

• 75 bps: "Stocks may rally initially on the print"

• 100 bps: "Short-term this is likely negative for stocks but think that view could fade later in the week as bond yields fall"

Moving expeditiously

The Fed's commentary will be key in providing hints as to how the Fed will handle interest rates for the rest of the year.

Deutsche Bank said it expects the Fed to "not commit to a specific policy path thereafter, except for an intention to "expeditiously" move towards a neutral policy stance."

"We expect Powell to leave all options open beyond the July meeting, and at minimum indicate that policy is more likely to move beyond neutral at some point."

"In our view, the surprisingly strong May CPI data have meaningfully lowered the probability that the Fed will be able downshift the pace of policy tightening at the September 21 meeting"

Deutsche now sees the Fed funds rate ending this year at 3.125% and peaking at 4.125% by the middle of 2023.

Can't rule out 100 bps

With the markets fully pricing in a 75 bp rate hike, the likelihood of 100 bps is slowing start to creep up.

“Chair Powell just hates surprising markets,” said Vincent Reinhart, chief economist at Dreyfus and Mellon, told Bloomberg.

The bigger picture

Global May CPI is tracking close to 10%, threatening economic growth as it squeezes purchasing power and accelerates rate hikes, said JP Morgan on Tuesday.

Inflation has accelerated in an alarming way, once concentrated towards core goods prices due to higher post pandemic demand to now broadening pressures and rapidly tightening labour markets, said the investment bank.

JP Morgan retained the view that "inflation-led bear markets do not bottom until you see peak inflation. If the market is correct, then that inflation peaks occurs around August/September."

"This points to what could be a very aggressive Q4 rally especially if we see growth and inflation stabilise."