Seventy-five basis points are the new 50 basis points.
A resolutely hawkish Federal Reserve is raising market expectations for steep interest rate hikes that would have been considered unthinkable (and crippling for the market) just two months ago.
Nomura said Friday that the FOMC would raise the federal funds rate by 75 basis points in June and July after rising 50 basis points in May. That would take the rate to 2.25%, a phenomenal tightening given that the Fed continued to ease by buying assets as recently as March.
The shift in market expectations for even more tightening came after Fed Chairman Jerome Powell told an IMF panel on Thursday that a 50 basis point hike in March was “on the table”. Perhaps even more relevant to markets, he said there was some merit in the anticipated tightening with upside risks to inflation and a historically tight labor market.
Traders were quick to price in a more aggressive hike as Powell spoke, with CME FedWatch now predicting an 85% chance the benchmark rate will hit a 1.5% to 1.75% range after the June meeting. . That would mean a 75 basis point hike in June if March gets the expected half-point boost.
Rumors of a hike of up to 75 basis points began last week when St. Louis Fed President James Bullard said he wouldn’t rule one out.
Before Powell spoke yesterday, San Francisco President Mary Daly added fuel to the fire, saying she would discuss with her colleagues the need for a 25, 50 or 75 point hike basic.
In fed funds futures, the market now expects a tightening of around 270 basis points for 2022, topping the 250 seen in 1994, with expectations now for the rate to hit 3% by March 2023, according to Deutsche Bank.
Deutsche Bank’s chief economist said yesterday that the Fed could raise rates as much as 5% by the time it tightens, a level not seen since 2006.
Estimate“Our US team has changed its appeal to the Fed,” Rob Subbaraman, head of global markets research at Nomura, wrote in an email seen by Bloomberg. “They now expect the FOMC to be even more focused on rate hikes, to get the funds rate back to neutral as quickly as possible to avoid a wage-price spiral.”
“We recognize that Fedspeak has not yet approved a 75 basis point hike, but in this high inflation regime, we believe the nature of the Fed’s forward guidance has changed – it has become more data dependent and more agile,” he said.
“We are in a new environment, dancing to a new tune, and the incremental way of reversing the mean of thinking about inflation and rates is likely to be misleading,” said the chief economist of the Deutsche Bank, David Folkerts-Landau. “Inflation is creeping into expectations and labor markets are historically tight.”
What this means for stocks and bonds: The liquidation of Treasuries accelerated as expectations for even more hawkish policy grew.
The 10-year Treasury yield (NYSEARCA:TBT) (TLT) reached 2.95% at the high of the day on Thursday and is back at that level this morning. The 2s10 curve has flattened and the 2-year yield (SHY) is up 7 basis points to 2.76% in early trading today.
Stocks started with a rally on Thursday, but the sharp rise in rates (especially real rates) reversed the trend and the S&P (SP500) (NYSEARCA: SPY) fell 1.5%, while the Nasdaq 100 (NDX) (QQQ) lost 2%.
Worries will increase in the equity market if the Fed steps back as Nomura predicts.
Investors “are in a new world of investing,” said eToro strategist Ben Laidler. “The sharp and endless repricing of Fed expectations for interest and inflation high for longer has led to bond volatility twice that of stocks and a tightening of the financial conditions index in the States. -United.”
“This leads to a lower valuation and rotation from growth to value,” he added. “Equities are being stress tested due to soaring bond yields. But there is a limit to the upside of yields. The Fed now has more control over yields with its huge balance sheet runoff, while high debt levels and the wide yield gap with global markets are constraints.”
BofA said stock market bulls are now an “endangered species,” but this is a contrarian bullish signal.