After Wednesday’s report that CPI inflation hit an annual 9.1% rate in June, a 100-basis-point interest rate increase at the Federal Reserve’s July 27 meeting is on the table. (Which is literally what Atlanta Fed President Raphael Bostic told reporters yesterday: “Everything is in play,” he said. Asked if that included raising rates by a full percentage point, he replied, “It would mean everything.)
Remember when, not very long ago, when we were debating whether or not the Federal Reserve might go for the shock and awe option of a 75-basis point increase at the July meeting? I guess “shock and awe” ain’t what it used to be.
Yesterday, odds of a 100-basis-point increase zoomed to 80.32% on the CME’s FedWatch Tool. This tool looks at prices in the Fed Funds Futures market to calculate the odds of a Fed move, so this is a measure of sentiment backed with real money. Today, with a day to think about it, the odds of a 100-basis-point increase have dropped back to 41.6%. But that’s a huge advance from the 7.4% odds of a 100-basis point increase back on June 14.
A 100-basis-point increase would be the largest since the Federal Reserve began using overnight interest rates to executive monetary policy in the early 1990s. For all practical purposes, then, this would be the biggest one-time interest rate increase ever.
Why is a 100-point interest rate increase on the table for two weeks from yesterday?
There’s a growing sense that inflation is more embedded in the economy than anticipated and that it is proving more stubbornly resistant to higher interest rates than expected. First, a 50-basis-point increase was supposed to get the economy’s attention. Then the Fed tried a 75-basis-point move. But with headline CPI inflation containing to accelerate–to an annual 9.1% rate in June from 8.6% in May–the thinking is that it will take a bigger whack across the nose to get the inflation moving lower.
Cynics, and I’d put myself in this group, also note that the Federal Reserve wants to get inflation moving lower sooner rather than later. The chorus singing “The Fed blew it” is only getting louder. The political pressure is only getting heavier. And the central bank would love to move inflation out of the spotlight well before the 2024 Presidential election.
I suspect there’s also a growing recognition at the Fed that some of the key drivers of headline inflation right now–energy and food prices–aren’t very susceptible to Fed control. So it may be time to ratchet up pressure on the rest of the economy to compensate. For example, if the Fed can’t use higher interest rates to make Americans eat less, so then the solution might be to raise interest rates fast enough and high enough so they’ll buy fewer cars.
And, finally (and don’t discount the importance of this), the Bank of Canada raised interest rates 100 basis points on Wednesday. That surprise move takes the “But no central bank does this” argument off the table. If the Bank of Canada can deliver that kind of move, then why not the Fed. Also, remember that the rise in odds on the CME FedWatch Tool means that a 100-basis-point increase no longer qualifies as a big surprise. The Fed hates to surprise the financial markets and add volatility to bond and stock prices, but with 40% of traders in the FedFunds Futures market thinking rates are going up 100 basis points in two weeks that move woiuldn’t be as big a surprise as it was in June.
For a Fed looking to make a big impact on inflation, 100 basis points may be exactly the right mix of shock and no surprise.
I’d expect that a 100-basis-point move by the Federal Reserve would push the U.S. dollar higher. In anticipation the Dollar Spot Index (DXY) is up another 0.64% and it is now up 13.62% for 2022 to date (as of 2:30 p.m. New York time on July 14.) The Invesco DB U.S. Dollar Bullish Fund ETF (UUP) that I have added to three of my portfolios over the last week, is up 0.61% today and is now up 12.69% for 2022 to date.
