The Fed Brings Out the Rate Hike Bazooka

Written on 14/06/2022 by Lukman Otunuga, Senior Research Analyst at FXTM

We’ve kicked off a week full of central bank meetings in brutal fashion, with volatility in the red zone. After scorching-hot inflation figures out of the US last Friday, selling in risky assets has continued as bond yields hit new cycle highs. Moves in the fixed income markets have been huge, as expectations for interest rate hikes have ratcheted up. All eyes are on the FOMC tomorrow, as the market goes into overdrive over how high policymakers will go to tame the inflation beast.

FOMC Meeting and Rate Hikes

Investors have become increasingly unnerved over stubbornly high price pressures and the prospect of aggressive monetary tightening by central banks. Last week’s US CPI shocker has stunned everyone and bets on the Fed raising rates to levels unthinkable only a few weeks ago, are now taken as a given. Markets have moved to virtual certainty that the FOMC will hike by three-quarters of a percentage point tomorrow, and not the previously projected 50bps.

This abrupt move was signalled by the Wall Street Journal late yesterday who is presumed to have been nudged by Fed officials to prepare the markets for this bigger move. Remember that the FOMC members are in the official “blackout” period which means they generally do not speak publicly between a week prior to the Saturday preceding a Fed meeting and the Thursday after that meeting.

With another 75bp rate hike on the cards for the July meeting, some Wall Street economists have mooted the idea of an even bigger 100bp hike. The market-implied end rate for mid-2023 for Fed Funds is now above 4%, having risen around 70bps since last Thursday before the US inflation report.

Dot Plot

As well as the rate decision, investors will get a look at the latest economic projections and the “dot plot”. The latter neatly illustrates the dispersion of members views around the central tendency forecast for the mid-point of the target range.

Last time out in March, the so-called “median dot”, the average Fed official’s view for where rates will be by end of this year, was at 1.875% before reaching 2.8% for end-2023. The high mark for CPI was 4.4% and 4.7% for the PCE figure, the Fed’s favoured gauge on inflation. Clearly, these forecasts and the dot plot will be upgraded substantially.

Press Conference and Possible Outcomes

Of course, much attention will also be on Jerome Powell’s press conference. If the Fed sticks to last week’s plan to hike by “only” 50bps, a dollar correction will surely follow, though it seems likely Powell will endeavour to convince the market that there are more hikes in the pipeline.

But evidence of sticky inflation over the coming months should keep hawkish pricing and also by extension, the dollar, underpinned, even if stocks markets can stage a recovery. Of course, risky assets have been impacted by the prospect of higher rates for some time, and that trend looks to be well entrenched currently.

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