The Federal Reserve is likely to deliver its most aggressive rate hikes in two decades Wednesday in order to help tame the fastest inflation in four as Chairman Jerome Powell appears ready to abandon his own guidance in order to win back the central bank's waning credibility on Wall Street.
Powell himself told reporters in May, following the Fed's biggest hike in twenty years -- a 50 basis point increase --that a similar move in June would bring the Fed Funds rate closer to the 'neutral' level to which he and his colleagues were aiming. He also went out of his way to play-down talk of a 75 basis point move.
That explicit guidance, as well as weeks of reinforcing statements from Fed officials that a 75 basis point rate hike wasn't being "actively considered", were torn to pieces last week by a white-hot May inflation reading -- and the underlying pressures that drove it -- which tipped Wall Street into betting on just such a move from Powell and his colleagues late today.
The CME Group's FedWatch now indicates a 96.5% chance of a 75 basis point hike, up from just 8.2% a week ago, which would take the FedFunds rate to a range of between 1.5% and 1.75%. A small portion of traders, in fact, are betting on the 'shock and awe' tactic of a 100 basis point move.
"Arguably the bigger story here is not the 75 basis point hike, but rather the way in which it has elbowed out the 50 basis point hike that had been boldly pre-announced," said ING rate strategists. "If the Fed were to go ahead and deliver on that promise of a 50 basis point hike it would cause quite a stir, as it would deviate significantly from the market discount in a way that is contrary to the direction that the Fed needs to go here."
"If the Fed were to deviate from the market discount, logically it should then be going for a 100 basis point hike," ING noted.
The market set-up, which includes sharply higher Treasury bond yields -- the highest since 2007, in fact, for 2-year notes --- and fresh 20-year highs for the U.S. dollar, is now largely reliant on a bigger and bolder move from the Fed both today and next month, as rate traders see a 93.1% chance of a 75 basis point hike that would take the Fed Funds rate to a range of between 2.25% and 2.5%.
The Fed's scheduled meeting comes just hours after an emergency gathering of policymakers at the European Central Bank, who convened Wednesday in Frankfurt amid wide-scale disruption in global and regional bond markets linked in part to the market's changing predictions of Fed rate hikes.
Benchmark 10-year German bund yields are now trading at the highest levels since 2014, at 1.77%, while the extra yield, or spread, that investors demand to hold lower-rated paper such as Italian government bonds has rise to around 2.4%, levels only last seen during the region's debt crisis.
But if inflation does slow later this year, a dynamic hinted at in the Fed's preferred PCE gauge in April, will the demand for larger hikes now find buyer's remorse in a few months time, given the outsized impact it's already had on domestic stock markets?
The tech-focused Nasdaq, the U.S. index most-sensitive to interest rate risk, is down more than 30% since Powell retired the word "transitory' from his inflation vocabulary in mid-December, a move that teed-up the prospect of more aggressive rate hikes.
The U.S. economy also slid into contraction over the first three months of the year -- and is now only growing at a 0.9% clip -- as higher interest rates have had little impact on inflation.
Retailers, restaurants, ad-focused tech companies and carmakers are all warning of demand destruction, input cost increases, rising borrowing costs and narrower profit margins. Some are starting to either cut back on hiring or let people go.
Housing prices are soaring, with the median new home price now 20% higher than it was last year, even as mortgage rates surge past 5% for the first time since 2011.
Gas prices are topping $5 a gallon for the first time on record, with higher pump prices in some states that show no signs of abating as U.S. crude oil trades firmly past the $120 per barrel mark.
New Fed projections on growth, inflation, unemployment and future rate hikes -- the so-called 'dot plots' will also be published alongside today's rate decision, which each potentially indicating a modest, but likely consistent, decline in underlying CPI pressures.
"The Fed does not have to play along with the markets’ hysteria," said Ian Shepherdson of Pantheon Macroeconomics. "We appreciate that the Fed is now under great pressure to 'do something' to fix inflation. They have to hike."
"But the inflation fix will not be more effective if the Fed hikes by 75 basis points today or next month, rather than 25 basis points, and the damage done to private sector wealth could inadvertently trigger a downturn which otherwise would be averted," he cautioned.
The Fed will announce its rate decision, as well as its new economic projections, at 2:00 pm Eastern time, with Powell's regular press briefing to follow 30 minutes later.
