📉Market expects a 75 bp rate hike from Fed today. Will Fed deliver the biggest hike in almost 30 years?
Market expectations for today's FOMC meeting are clear - US central bank will deliver a 75 basis point rate hike. Moreover, market prices in another such big move in July! It is a result of inflation still exceeding expectations and failing to drop even after tightening that was already delivered. Nevertheless, there were not too many comments from Fed members pointing to a possibility of a hike bigger than 50 basis points. It does not mean that Fed rules out the biggest rate hike since 1994 as the Reserve said numerous times that it will act if needed. One thing that Fed certainly wants to avoid is the wage-price spiral that was persistent throughout the 70s. Where is US500 and EURUSD now? How can those markets react to today's decision?
What to expect from today's Fed meeting? What we need to know before the decision?
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Fed should deliver a 75 basis point rate hike even in spite of an increased risk of recession
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Bigger rate hike is possible due to higher inflation forecasts. Possibility of a similarly big hike at next meeting should be well communicated
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Major banks like Nomura or Goldman Sachs expect the Fed to deliver a 75 rate hike. Median estimate among economists remains at 50 bp
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Fed may signal increased reduction in QE programme, what would magnift pressure on equities. It is not the base case scenario however
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Dot-plot will likely continue to underestimate the final rate. It pointed to an end-cycle rate of 2.8% and now it is expected closer to 3.5%. However, markets sees possibility of Fed funds rate jumping to as high as 4% in this cycle
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Fed wants to avoid 70s scenario when inflation expectations de-anchored due to slow process of rate hikes
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The faster Fed gets inflation under control, the better for markets, even if it leads to a slowdown or short-term recession
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Correction on Wall Street during the 70s resulted in a 40% drop during the first phase of monetary policy tightening. A quick rate cuts that followed triggered a 20-year period of gains that exceeded 20%
What conclusions should we draw? A 50 basis point rate hike may lead to a brief improvement in moods but will not improve the fundamental outlook. Bigger and faster rates hikes may lead to a recession but will also allow the Fed to provide support quicker. Higher taxes will cool the economy what should lower oil prices - a key driver of inflation.
Inflation still remain far off the levels seen in the 70s but if current interest rates do not rise quickly, we may once again experience de-anchoring of inflation expectations. The sooner Fed decides to match market expectations, the quicker markets will be ready to rebound. Source: Bloomberg
Currently, Fed sees end-of-cycle rate at 2.8% but dot-plot release today will likely show median more closely to 3.5%. Bloomberg consensus and interest rate markets see end-of-cycle rate as high as 4% next year. If Fed accelerates tightening, it will be able to more quickly resume support for the economy. Source: xStation5
A look at the markets
EURUSD
US dollar is strong and will likely continue to remain in the near future, unless the Fed shows that it has managed to tame inflation expectations. EURUSD has always recovered following a break of 25 area at RSI indicator and further rebound from 17 area. The pair usually gained 100-300 pips in such situations. The lower-end of the range was already reached and the higher would point to a potential move to as high as 1.07. US dollar index remained relatively stable during the first phase of tightening in the 70s suggesting the USD may remain stable now as well. Source: xStation5
US500
US500 reacted negatively to 38.2% retracement and remains in technical bear market territory. Key resistance for the index can be found in the 3,900 pts area, where a bearish price gap can be found. A key support for the index can be found in the 3,500 pts area, where the 200-week moving average as well as 50% retracement of the whole post-pandemic recovery move can be found. If Fed fails to deliver a 75 basis point rate hike, a jump in equities may be expected. However, it should be rather a temporary jump. Source: xStation5
US500 reaction to previous rate hikes
At the end of 6-hour period after rate hike decisions during the current and previous cycle, US500 traded either flat or slightly lower. However, it should be noted that neither of those rate hikes was a surprise for markets. Source: Bloomberg
