The US Federal Reserve is widely expected to raise interest rates by 75 basis points or 0.75% at its July policy meeting this week to a range of 2.25% to 2.50%, according to economists. Fed governor Christopher Waller has in the past few weeks signalled that the central bank will deliver the same size interest rate increase as last month, following an inflation report showing that consumer prices in June rose to fresh 40-year highs of 9.1% in the US. “I support another 75-basis point increase” at the next FOMC meeting, Waller said at an event. Market participants world over will be focused on the FOMC statement on inflation, growth outlook and guidance for the monetary policy direction in the near term.
Possibility of larger than 75 bps rate hike: Fed governor Christopher Waller
“However, my base case for July depends on incoming data.We have important data releases on retail sales and housing coming in before the July meeting. If that data comes in materially stronger than expected, it would make me lean towards a larger hike at the July meeting to the extent it shows demand is not slowing down fast enough to get inflation down,” he further said. Note that US retail sales climbed in June by more than forecast in a broad advance, suggesting resilient consumer spending despite high inflation. Meanwhile, US existing home sales fell for a fifth straight month in June to the lowest level in two years.
It is worth noting that since March 2022, Fed has raised rates by 150 bps, which includes the 75 bps rate hike in June. For the upcoming July policy, the debate is over 75 bps versus 100 bps. According to Waller, higher rates will stifle business, but will not kill business. He highlighted that the focus will be inflation; first and foremost.
Focus shift from inflation to recession
“Markets will be closely watching the Fed action in the coming FOMC meeting on 27th July, as a rate hike of 75bps is mostly priced in. However, more than the rate hike, it is the Fed’s commentary and forward guidance on inflation and growth that will move the markets. We are seeing some easing in inflation expectations driven by the recent fall in commodity prices. The 1 year forward inflation expectation in the US has dipped from 5.4% in April to 5.2% this month. Also, the Fed’s preferred gauge of inflation, Personal Consumption Expenditures (PCE) price index, which measures the change in the cost of goods and services consumed by all households, came at 6.3% y-o-y for May against record high of 6.6% y-o-y in March. We are already seeing a sort of rally in risk assets globally as investors are anticipating lower inflation in coming months.” said Ritika Chhabra- Economic and Quant Analyst, Prabhudas Lilladher
“The focus now seems to have shifted from inflation to how severe the recession in the developed world is going to be. The US economy is in an interesting situation. On one hand, the consumer confidence is at the lowest level since 2008, on the other hand, the labor market is tight and consumer spending is robust, thanks to high savings during Covid times. That said, the US companies are beginning to forecast lower earnings growth over next few quarters and are adjusting their hiring plans accordingly. As the job market begins to get hit, the households will also slowdown their spending, that is expected to pan out over early next year. The futures market for federal funds on Chicago’s CME exchange shows that the rate traders are anticipating a recession in Q1 2023, eventually compelling Fed to cut rates in Feb 2023 meeting. So far, the Fed Chair Jerome Powell continues to insist the U.S. economy is far from a recession. Thus, any change in stance on inflation or growth will be closely watched for,” she added.
US Fed may consider raising rates thrice this year
“Market participants will be keenly keeping an eye on the advance reading of second quarter of GDP and a negative number could reaffirm expectations of a slowdown in the US economy. GDP has contracted in the last quarter and another quarter of contraction could put the economy on the brink of recession. The Fed could consider raising rates thrice this year; with one at the July meeting and the other two in the next couple of meetings after that. But the rate hikes after the July meeting could be smaller than the one we have seen in the recent ones,” said Gaurang Somaiya, Forex & Bullion Analyst, Motilal Oswal Financial Services.
“Recent data has shown signs of an economic slowdown while inflation remains stubbornly high, with claims for jobless benefits rising to its highest in eight months last week. Market participants at this point of time have discounted a 75bps rate hike with a hawkish stance and a 100bps rate hike could strengthen the dollar against its major crosses,” he added.
75 bps rate hike to increase recession risks
Gary Schlossberg, Global Strategist, Wells Fargo Investment Institute told CNBC TV18, “We are looking for a 75 bps increase in the Fed funds target rate on July 27 and odds favour yet another 75 bps increase on September 14.” Abhilash Narayan, Senior Investment Strategist-Group Wealth Management at Standard Chartered Bank Singapore also echoed the same expectation saying, “The latest inflation print in the US needs that Fed is quite likely to hike rate by 75 bps, which is going to increase recession risks further.”
What would it take for Fed to slow rate hike pace
UBS Wealth Managements expects Fed Chair Powell to continue to drive home the message that inflation is unacceptably high and that the central bank is solely focused on getting it under control. In June, the Fed’s dot plot, which it uses to signal its outlook for the path of interest rates, showed the median year-end projection for the federal funds rate at 3.4%. The estimate for the end of 2023 was almost 3.8%. “With no dot plot this time, we expect to see more questioning on how restrictive the Fed expects to get in 2022 and what it would take to get them to pause or slow the pace of hikes.” the wealth manager said.
FOMC may lift rates by a half percentage point in September
According to economists surveyed by Bloomberg, Federal Reserve Chair Jerome Powell is likely to slow the pace of interest-rate increases after front-loading policy with a second straight 75 basis-point hike. They expect the Federal Open Market Committee (FOMC) to lift rates by a half percentage point in September, then shift to quarter-point hikes at the remaining two meetings of the year. The survey of 44 economists conducted from July 15 to 20 forecasted that the US central bank will raise rates by another 25 basis points in early 2023, reaching a peak of 3.75% before pausing and starting to cut rates before the end of the year.
“The still strong labor market and solid consumer spending provide the leeway for the Fed to continue to quickly raise the policy rate,” Oxford Economics chief US economist Kathy Bostjancic was quoted saying in the Bloomberg report.