Fed Goes Large Again With More to Come

Written on 20/09/2022 by Lukman Otunuga, Senior Research Analyst at FXTM

Fed to Ramp Up Hawkish Rhetoric

Markets expect the U.S Federal Reserve will hike the target range by another 75bps at its meeting tomorrow. This would make it three jumbo-sized rate hikes in a row and take the Fed Funds rate up to 3%-3.25%, which is nearing “restrictive territory”. There is much speculation about whether the FOMC raise rates by a monster 100bps, but markets are giving this less than a one in five chance of this happening. The extension of the “dot plots” through 2025 will offer much insight into how Fed officials view the evolving economic cycle.

The central focus for FOMC policymakers at present is fighting raging inflation and bringing price pressures back to the Fed’s target of 2%. Front-loading of interest rate rises has been the weapon of choice for tightening policy while quantitative tightening ramped up earlier this month to $95 billion per month.

The latest inflation data came in hotter-than-expected and shocked markets into further raising the chances of rates staying higher for longer. August CPI figures highlighted the persistent and sticky nature of inflation, driven by shelter prices which have a lagging effect and continue to rise.

Any chance of a “hike of the century”?

After the shock US inflation report last week, money markets went into overdrive and saw over a 30% chance of a 100bp rate hike at tomorrow’s FOMC meeting. That probability has now come down to around 17% according to the CME FedWatch Tool. We’ve had plenty of hawkish Fedspeak recently, but it does seem that a mega-hike would probably unnerve Wall Street as the Fed hasn’t been willing to take that step before.

A rate move of that size may also imply some panic at the world’s most important central bank. It would increase the likelihood that the FOMC will overtighten policy and decrease the chances of a soft landing.

Fed Statement and Dot Plot in Focus

The statement language will be guided by the latest Summary of Economic Projections, which were last released in June. Meaningful changes in expectations are anticipated with the forecast for the Fed funds rate shown in the dot plot expected to be more hawkish. The previous projections saw rates at 3.4% at the end of this year, followed by 3.8% by the end of 2023. Markets currently see rates peaking at 4.5% in March and to be cut to 4% by December next year. Inflation forecasts are likely to be lifted while growth estimates are lowered.

Market Reaction and the Dollar

The greenback has hit multi-year highs this year while risk markets have suffered as the rate hike cycle has ramped up with front-loading. Tighter monetary policy increases the headwinds for risk assets, and this should help support the dollar going forward. In the near term, a 75bp “hawkish hike” is the minimum expected by markets.

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