Does 100 bps rate hike by the Fed look likely in July 2022?

Fed may weigh 100 bps rate hike in July-22
Fed may weigh 100 bps rate hike in July-22

Global Market
by 5paisa Research Team Last Updated: 2022-07-15T21:37:11+05:30

How do you judge the probability if the Fed will hike the rates by 75 bps or 100 bps. One way is to look at the CME Fedwatch. It is a measure of the probability of the extent of rate hike and the possible quantum of rate hike based on the rates implied in Fed Futures trading. That is something like the implied volatility calculations wherein the probability implied in the futures prices is considered by working backwards. Recently, the futures on federal funds rate have increased the chances of 100 bps rate in the July FOMC meeting.

This is largely thanks to the higher than expected inflation coming in for the month of June 2022 at 9.1%. This is the highest consumer inflation level for the last 41 years. Of course, one can argue that the rates are decided based on the PCE inflation and not the consumer inflation but the consumer inflation does serve as a good proxy. It is not just the level of inflation but the fact that despite the Fed hiking rates by 150 basis points, the inflation has just shown no signs of relenting. It is just getting hotter than expected. 

One needs to look at the way the probability implied in the Fed Funds rate have changed prior to the release of the inflation data and post the release of the inflation data. For instance, prior to the release of the CPI data, fed funds futures had priced in merely a 0.2% probability of a 100 basis-point hike this month. However, after the CPI data was released at 9.1%, the probability of a 100 bps rate hike as per CME Fedwatch spiked from 0.2% to 33%, before it attained a more tempered level of 28%. Probability for 75 bps rate hike is 72%.

This would also largely change the equations of how soon the Fed would hike rates from here and how rapidly they will move towards their targets. Now a Reuters poll estimates of consumer inflation for the full year is expected at 8.8%. This shift in probability also means that the markets are now factoring in the Fed funds rate reaching a level of 3.6% by the end of year 2022 as compared to the original estimate of 3.41% by the end of 2022. That means, the Fed would cover another 200 bps between July and December 2022.

There would be a small policy dilemma for the Fed in going so aggressive. If the impact on the inflation levels is not immediate or potent, then it does raise some serious questions over the efficacy of the policy stance adopted by the Fed. There is also an issue of credibility since the explanation all along was that the sharp spike in rates would automatically control inflation. Such massive rate hikes are unprecedented in American central bank history and so many such large rate hikes in succession have not been seen. That is the dilemma.

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