Last of the “jumbo” Fed Hikes?

Written on 26/07/2022 by Lukman Otunuga, Senior Research Analyst at FXTM

This would take the Fed Funds rate back to neutral at 2.25%-2.5%, according to the Fed’s own estimate. The key question will be what Fed Chair Powell signals the world’s most important central bank does next and the FOMC’s guidance through the rest of the year. A quicker tightening pace will lower inflation faster. But it will also increase the risk of a hard landing and potentially hasten a recession.

The strong June jobs report and even stronger recent CPI data raised the possibility of a 100bp rate move at this July meeting. Indeed, the fact that the 9.1% inflation print was released on the same day that the Bank of Canada sprung a hawkish shock by hiking by 100bp saw the market price in nearly an 80% chance of a jumbo rate rise happening in the U.S. But subsequent speeches by a few Fed officials, including some of the more hawkish members, indicated that 75bps remained the baseline expectation.

Money markets now price in around a 25% possibility of a 1% move. The terminal rate, where traders think rates will peak, has moved lower in recent weeks and is now roughly around 3.35%. The September meeting has roughly 59bp of hikes priced in.

Forward guidance to be updated?

There is no new dot plot or economic forecast to be released at this meeting. That means the focus will be the post-meeting statement language. The current forward guidance – “ongoing increases in the target range will be appropriate” – has been in the statement since March, so there is speculation that this needs to be updated, especially with the range now getting to neutral.

The last few meetings have seen Chair Powell signal the expected size of the next rate move. That said, this was subsequently changed at the last minute by briefing a few journalists to expect a bigger rate hike. There are two fresh job reports between now and the next FOMC meeting. Will Powell want to risk attaching his colours to a tightening mast in late July?

The continued strength of the labour market will likely serve as evidence that the economy can bear more policy tightening. But the strength in core inflation leaves little room for complacency, even if the recent falls in gasoline prices offer some hope that 9.1% is “peak inflation”.

Market positioning and the dollar

The greenback has strengthened 12% this year and equities are off nearly 20%. Along with the sharp front-loading of rate hikes as the Fed slams on the brakes, both the economy and inflation are being squeezed tightly. More recently, a loading up of long positions in the dollar took place as EUR/USD crossed parity earlier in the month. Bullish dollar positioning is now a stone’s throw from the May highs. Many investment banks believe the buck will strengthen as investors adjust to a softer growth outlook outside the U.S. A relatively hawkish FOMC would also add to this sentiment.

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