Will The Fed Raise By 75 Basis Points?

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Fed rate hike warning sign

JimVallee / iStock via Getty Images

By Tajinder Dhillon

Those who subscribe to “sell in May and leave” would have avoided one of the two times this year that the S&P 500 fell more than five percent in a single week (the other case happened in late January).

Many thought U.S. inflation expectations peaked in March this year, as April figures saw a decline in both the general CPI and the core CPI. However, the general CPI reached another new high in May, rising by 8.6% year-on-year, a 40-year high, as shown in Figure 1. The core CPI also remained stubborn. in addition, as it increased by 0.6% without showing a decrease from April.

Figure 1 - US inflation rates

Figure 1 – US inflation rates (Refinitive Datastream / Tajinder Dhillon, CFA)

Figure 2 breaks down the CPI by weight to show which categories contribute the most to the CPI. Housing, which includes housing, rent, domestic energy and utilities, has the highest weight in the basket with 42.4%. Transport includes both private and public transport with the second highest weight, with 18.2%, followed by food and beverages with 14.3%.

Figure 2: CPI basket weights

Figure 2: CPI basket weights (Refinitive Datastream / Tajinder Dhillon, CFA)

If we look at each category in more detail, house prices have risen 5.4% year-on-year, while rental prices have risen 5.1%. ‘Staycationers’ will find that hotel prices have increased by 22.4% and reaching a destination by car (using petrol) or plane will be 48.7% and 37.4% more expensive, respectively.

Figure 3 - US inflation by category

Figure 3 – US inflation by category (Refinitive Datastream / Tajinder Dhillon, CFA)

June Fed meeting

With the Federal Reserve meeting on June 15th, Refinitiv Workspace offers a look at market expectations on the path of interest rates. The July Fed Funds futures contract is currently priced at 98.5375, which implies a policy rate of 1.46%. This translates into an 80% probability that the policy rate is between 1.25 and 1.50%, according to sample 4.

Although a 50 bp rise is already known, what is most notable is the 20% probability at the time of writing that the reference rate may rise to 1.50-1.75% , which would probably be a 75 bp rise. (Update: On June 13, the probability of a 75 bp rise increased from 20% to 69% according to the IRPR application).

Figure 4 - Interest rate probability

Figure 4 – Interest rate probability (Refinitive workspace)

Through Annex 4, we can look at the July meeting, which shows a 55% probability that the political rate could fall between 2.00 and 2.25%. In the end, we can see a total of 125 bp in rate hikes between the June and July meeting, whether it’s a 75 bp hike followed by a 50 bp hike or vice versa. Given the May inflation figures, a case for the former is beyond doubt.

Even if the policy rate is 2.25% in July, it will still be off-mark if you look at the bond market as shown in Figure 5. The yield on two-year bonds (line black) reached an all-time high of 3.0%, which can be seen as an indicator of the political rate. In addition, the U.S. 10-year and 2-year spread is at 9 basis points, indicating a flattened yield curve.

We also overlap long-term inflation expectations by using the red and gray line to indicate that inflation in the next five years will still be above the 2% target, which will increase pressure on the Fed to fight the Fed. inflation.

Figure 5 - Bond markets and inflation expectations

Figure 5 – Bond markets and inflation expectations (Refinitive Datastream / Tajinder Dhillon, CFA)

The Personal Consumption Spending Index (PCE) will be a key release in May, as the core PCE is a preferred measure used by the Federal Reserve to measure market inflation temperatures. Core PCE peaked at 5.3% in February this year and fell to 4.9% in April, as shown in Figure 1. An increase in this indicator in May is undoubtedly will increase pressure on the Federal Reserve to fight inflation. Please note that the next release of Core PCE is expected to be on June 30ththtwo weeks after June 15thth Fed meeting.

Original publication

Editor’s note: The summary peaks in this article were chosen by the editors of Seeking Alpha.

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