Wall Street Breakfast: Ladies And Gentlemen … the Fed

Wall Street Breakfast: Ladies And Gentlemen … the Fed

In a packed Wall Street week, the headlining act arrives. The Federal Reserve releases its decision on interest rates this afternoon with a hike of 75 basis points priced in by the markets.


The FOMC seeks to prove to investors that they’re serious about reining in inflation. Traders, though, are likely to home in on cues for when the central bank will pause tightening.

The CPI jumped 9.1% in June from a year ago, its fastest rate in more than 40 years, accelerating from 8.6% in May. And the PPI surged 11.3% in June Y/Y, up from 10.9% in May. In response, traders started pricing in a 100-basis-point rate hike in July, but Fed officials quickly pushed back in their public comments, guiding them back to a 75-bps increase.

The CME FedWatch tool puts a probability of 75.1% on a 75-bps rate hike to 2.25%-2.5% for the July meeting and a 24.9% probability for a 100-bps increase; for September, markets are pricing in a 49.6% probability for a 50-bps hike on top of that and a 42% chance of a 75-bps increase.

Scaling the peak: Debates over the size of the rate hike miss the point, said RSM Chief U.S. economist Joseph Brusuelas on Friday. “The far more important issue is just how far into restrictive terrain central bankers should lift the policy rate, and at what point they will choose to take the central bank’s foot off the monetary brakes and allow the economy space to further absorb the rate shock the Fed has imposed on the economy to restore price stability,” he wrote.

Lifting the rate to 2.25%-2.50% from the current 1.50%-1.75% moves policy restrictive territory, even at the risk of a slower economy, Brusuelas said. RSM sees the Fed continuing to raise rates until it reaches 3.25%-3.5% before it pauses to assess its impact on growth, inflation and employment, he added.

“Another three-quarter percentage point rate hike will take the benchmark fed funds rate back to where it was in July 2019, at the peak of the last cycle,” Bankrate Chief Financial Analyst Greg McBride said. “But with inflation running north of 9%, we’re not at the finish line and there will be more interest rate increases to come in the months ahead.”

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Morgan Stanley economists led by Ellen Zentner expect the fed funds rate to peak at 3.625% in December 2022, with the Fed taking the first steps toward normalizing the rate by the end of 2023.

What stocks say: Morgan Stanley strategist Mike Wilson says equity markets may already be pricing in a pause in the Fed’s rate hikes. In the last four economic cycles, the Fed paused its tightening well before the recession arrived, and the period between the pause and the economic downturn was “good for stocks, often VERY good,” he wrote in a note on Monday. “The problem this time is that the pause is likely to come too late.” Wilson still sees the Fed continuing to raise rates to fight stubbornly high inflation. “The battle on inflation should have begun a year ago, not now when demand destruction is already well developed and likely to take care of inflation on its own.”

J.P. Morgan equity strategists headed by Mislav Matejka, meanwhile, see the growth-policy tradeoff, which worsened from both sides in the first half of 2022, as “likely to improve as we move through 2H.” With challenged activity momentum and softer labor markets, “the reset in activity is what many want to see.”

“Crucially, this could open the doors to a more balanced Fed, and is driving a rollover in bond yields, potentially peaking USD and a leveling off in inflation,” Metejka said. This could be a case of “bad data is starting to be seen as good,” he added. The broad pullback in commodity prices “should be interpreted not only as a traditional indicator of softer demand, but also as bringing the relief in inflation pressures.