InvestorQ : Do you see a 75 bps rate hike by the Fed or a 100 bps rate hike in July FOMC meeting?
Moii Chavate made post

Do you see a 75 bps rate hike by the Fed or a 100 bps rate hike in July FOMC meeting?

Tisha Malhotra answered.
4 weeks ago

As of now the debate is veering both ways, but one way to take a call is based on the probabilities implied in the CME Fedwatch. The CME Fedwatch measures the probability of rate hikes and the quantum of rate hikes based on the rates implied in Fed Futures trading. That is debatable because you assume that the prices are a correct reflection of the reality, which may not be the case. Th CME Fedwatch has recently increased the chances of 100 bps rate in the July FOMC meeting and that is one factor that is driving expectations.

This shift in probability is largely thanks to higher than expected inflation for June 2022 at 9.1%. Remember, this is the highest consumer inflation level in the last 41 years. The consumer inflation may not be the direct determinant of rate stance of the Fed but it does serve as a good proxy. What the markets would really be worried about is that despite the Fed hiking rates by 150 basis points, the inflation has just shown no signs of relenting. On the contrary, the inflation number is just going from bad to worse.

It is not just about the absolute probability but also about how this probability implied in the Fed Funds rate have changed. Consider this example. Ahead of the release of the consumer inflation data, fed funds futures had priced 0.2% probability of a 100 basis-point hike in the July FOMC meet. However, post the CPI data at 9.1%, the probability of 100 bps rate hike spiked from 0.2% to 33%. That is a very high probability of an even happening. It now has tempered further to 28% while the 75 bps rate hike has a probability of 100 bps.

A recent Reuters poll estimates consumer inflation for 2022 at 8.8%. The shift in probability assumes the Fed funds rate reaching a level of 3.6% by the end of year 2022. Originally, the estimate was just 3.41% for the end of 2022. That effectively means, the Fed would cover another 200 bps between July and December 2022. However, as much as this looks good and simple on paper, implementing a 100 bps will be tough and the FOMC itself is likely to be divided since it would be unprecedented and would also tie the hands of the Fed.

That is because, hiking the rates by 100 bps creates a policy dilemma for the Fed. Post the hike, if the impact on inflation levels is not immediate or powerful enough, it raises some serious questions over the efficacy of the policy stance adopted by the Fed. From the perspective of the Fed, it is also an issue of credibility since the expectation has been that sharply higher rates would automatically control inflation. Due to this dilemma, the Fed may adopt a more calibrated approach to hiking rates.