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Fed meeting: 75 bps rate hike a certainty but 100 bps can't be ruled out

More than the quantum of the hike, the Fed’s guidance about the path ahead for interest rates will steer the markets

July 27, 2022 / 07:24 PM IST

The Federal Open Market Committee (FOMC) meeting for the July leg of the rate hike cycle will get underway in a few hours with the agenda of freezing the quantum of the interest rate hike that will be announced on July 27.

The US Federal Reserve has a huge balancing act to do, especially with red-hot high inflation on the one hand and deteriorating economic growth on the other.

US inflation crossed the 9 percent mark, the most in four decades and well above the Fed’s target of 2 percent. At the same time, jobless claims in are on an upward trend and last week rose to their highest level in eight months. These are early signals of a deteriorating economy.

Rate hike expectations

The US Fed, which raised interest rates by 75 bps in June to a range of 1.5-1.75 percent, is likely to deliver another large interest rate hike for the second time in a row to stamp out inflation, which jumped to 9.1 percent on an annual basis in June. Experts are confident the Fed will go for a 75 bps (100 bps = 1 percent) hike in its July policy meeting with some not completely ruling out the possibility of a 100 bps hike due to worse-than-expected inflation numbers.

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“The probability of a 100 bps points hike by the US Federal Reserve seems to be growing, as per Bloomberg data. However, the policy rate hike could be 75 bps this time also,” said Gaurav Dua, SVP, head–capital market strategy at Sharekhan by BNP Paribas.

The drop in commodity prices, high-frequency data points indicating a sharp slowdown in the economy and the concerned voices from large companies, including Tesla, JP Morgan and Walmart, could restrict the Federal Reserve from taking a very aggressive approach, Dua added.

The US Fed has already made its aggressive stance clear, so the chances of a 100 bps hike cannot be ignored. CME’s FedWatch Tool suggests a 25.5 percent probability of a bigger hike than the majority expects.

“It is reflected from the Fed member’s comments earlier that persistent high inflation is their major concern and they continue to maintain that they can avoid a recession and execute a soft landing of the economy,” said Ravi Singh, vice president and head of research at ShareIndia.

Fed Chairman Jerome Powell has said that failing to restore price stability would be a “bigger mistake” than pushing the US into a recession. So the Fed will most probably take an aggressive stance of an at least 75 bps hike.

“The Fed is treading on a new course after an era of unprecedented monetary support, so more than the outcome of the meeting, the Fed’s guidance about the rate hike path ahead would be closely parsed by the market participants that will steer the direction of the markets going ahead,” said Sugandha Sachdeva, VP- commodity & currency research at Religare Broking.

Experts expect that after this month’s hike, there will be a 50 bps increase in September followed by a 25 bps hike in November and December to take the Feds Fund rate to 3.25-3.5 percent by the year-end.

“Another round of aggressive rate hike may be there before we see some tapering as the inflationary pressure due to commodities has already started easing,” said Arun Malhotra, founding partner at CapGrow Capital Advisors.

Also read: Taking Stock | Second day of selling pulls market down, all eyes on Fed meeting

Impact on markets

Experts are of the opinion that the market has already priced in a hike of 75 bps. While an increase in interest rates by this quantum may not impact the markets, any aggressive guidance for the months ahead might make them more jittery and volatile.

“The market moves ahead of the event and has already discounted an interest rate hike of 75 bps, unless there’s a new rabbit out of the bag,” said Basant Maheshwari, co-founder of Basant Maheshwari Wealth Advisers. “Normally, the US Fed doesn’t surprise but prepares the market much before the actual event.”

Experts said the peak Fed funds rate during this cycle will be about 3.5 percent and almost the entire increase will take place during the current calendar year.

“The financial market seems to have factored in a peak policy rate of 3.5 percent during this cycle, as well as a 75 bps rate hike in the July policy. Therefore, unless the Fed goes for a higher than 75 bps rate hike this time and/or changes the guidance towards being more hawkish, we do not expect any major reaction from the financial markets,” said Sujan Hajra, chief economist at Anand Rathi Shares & Stock Brokers.

However, the market direction will also depend on the commentary/guidance along with the rate hike.

“There is a section of the market that expects the US Federal Reserve to at least take a pause by the end of CY2022 to gauge the impact of rate hikes on inflationary expectations and the possibility of hard landing in the economy. Any indication towards the same would be taken positively by the equity markets,” added Dua of Sharekhan by BNP Paribas.

Outlook

Recent inflation numbers suggest that the Fed could stick to a 75 bps rate hike but the cooling off in commodity prices from recent highs could trim expectations of aggressive rate hikes in the next meetings.

“As the Fed hikes rates, mortgage, auto, or business loans will become costly because of which consumers and businesses will likely borrow and spend less, cooling the economy and slowing price increases,” said Sonam Srivastava, founder of Wright Research. “But hiking rates is tricky in a struggling economy and the easing of prices might be around the corner as oil and metal prices have declined and inventory levels in the US are high.”

Even though inflation is expected to stay above historical averages, softening of prices might prompt the Fed to slow down the pace of rate hikes to avoid a hard landing for the US economy.

“Amid a strong labour market and healthy consumer spending, the Q2 US GDP data will be quite crucial in guiding the ambitious rate hike campaign of the US Fed, following a 1.6 percent contraction in the first three months of the year,” added Sachdeva of Religare Broking.

Once the Fed is able to tame inflation or rein in its meteoric rise, it will return to its second most important priority – employment and growth and at that time, some experts said the Fed might actually start reducing rates from the first quarter of 2023.

Disclaimer: The views and investment tips of experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before making any investment decisions.
Gaurav Sharma
first published: Jul 26, 2022 05:24 pm
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