At today's FOMC Meeting, we expect another 75 basis point hike in the Fed Funds Rate.
This will bring the target range up from 1.50-1.75% to 2.25-2.50%, which is seen as close to the long-run “neutral rate” of interest (neither easy nor tight).
We will also look for comments about the state of the economy and whether the Fed is monitoring or commenting on the recent deceleration in business activity in the U.S.
The Market's View:
The markets are pricing in a 75bp hike this meeting, in line with what has been communicated to the public by most Fed officials.
On top of the 75bp hike, the markets are pricing in a high probability of the Fed Funds Rate reaching 3.25-3.50% in December 2022. To achieve that level of Fed Funds Rate by December, the FOMC would need to distribute 100bps of hikes over three remaining meetings this year (September, November, and December). Since 100bps spread out over three months would likely result in multiple smaller 25-50bp hikes, the market assumes the FOMC has displayed its most aggressive policy in June and July. This is in line with our expectation (see our note, FOMC Preview: Peak Fed Hawkishness?) that the path of Fed hikes will become more gradual at the end of 2022.
We see the runway for the Fed to raise interest rates as short and limited as economic data is downshifting with:
(a) record low consumer sentiment data
(b) contractionary signals from PMI data
(c) this year’s crash in commodity and logistics prices
(d) the U.S housing market cooling down
With another “jumbo hike” of 75bps, we believe that economic data will contract even faster through August and the first half of September (before the next FOMC meeting). This may, in our view, encourage the Fed to either pause their hikes for one meeting or reduce the pace of hikes dramatically, to avoid a more serious and steeper decline in economic activity. Post-September, we see the Fed raising interest rates again in November and December at 25bp intervals, as core inflation remains above trend through the first half of 2023.
The 100bp Scenario:
There is a very low probability of the Fed raising rates by 100bp this week – arguably, a 75bp move could be seen as a “dovish hike”, like the 75bp Greenspan hike in ‘94.
However, the economic backdrop is much different today than in 1994, and the more likely outcome of a 100bp hike would lead to a faster deterioration in economic data across almost all sectors.
Ultimately, a more aggressive Fed (more hikes today) would mean sooner dovishness (faster cuts tomorrow) and so the impact on risk assets, while initially bad, may end up positive.