I know this seems bass-ackwards.
Stocks have spent two days in a vigorous sell off because of fears of higher interest rates and worries, after Friday’s surprise surge in CPI inflation to an 8.6% annual rate in May, that the Fed might decide to raise interest rates by 75 bass points rather than the expected 50 basis points at the Wednesday, June 15, meeting of its Open Market Committee.
And now the actual 75 basis-point increase might produce a rally?
Where’s the logic in that?
The odds of a rally on a 75 basis point increase (and mind you, I still think 50 basis points is much more likely) rest on this emerging Wall Street narrative.
The Fed, spooked by Friday’s inflation report, will raise rates by a bigger than expected 75 basis points on Wednesday, the developing narrative goes, and then increase rates by another 75 basis points at its July 27 meeting. That would take the Fed’s benchmark short term interest rate to a range of 2.25% to 2.50% from the current rate of 0.75% to 1.00%.
And then, this thinking goes, the Fed would raise interest rates by just 25 basis points at its September 21 meeting and by another 25 basis points on November 2 and December 14. That would take the Fed’s target rate to a range of 3% to 3.25%.
Which just happens to be the level that economists and market prices suggest for the end of 2022.
And then, this story goes, the Fed would rest for most of 2023 watching the economy slow and inflation fall, until it actually cut interest rates by 50 basis points in the last part of the year. And then again in 2024.
This story hasn’t yet gained majority credence on Wall Street. The CME Fed Watch Tool is saying the odds of a 50 basis point increase in September stands at 64%.
But it is an very positive story since it promises a relatively quick end to big interest rate increases from the Federal Reserve and a relatively quick end to all interest rate increases. And, finally, it dangles the prospect of new interest rate cuts in front of investors before the end of 2023.
If the Federal Reserve actually raises rates by 75 basis points tomorrow, this narrative will gain more converts. Possibly enough to push stock prices higher. At least until those pesky inflation numbers cast doubt on that story and revive fears of a longer cycle of interest rate increases.