Two developments since the May CPI report reinforce the case for a more hawkish FOMC meeting on Wednesday, in our view. First, the startling rise in the longer-term inflation expectations in the University of Michigan’s consumer sentiment survey could imply a higher level of the nominal neutral interest rate. Second, according to the WSJ this afternoon, the Committee will not go into tomorrow’s two-day meeting constrained by their previous guidance that a 50bp meeting “would likely be appropriate.” As such, we now look for a 75bp hike on Wednesday. To the extent today’s report about Fed officials considering “surprising markets with a larger-than-expected 0.75pp interest rate increase” helps reinforce expectations for such a move, one might wonder whether the true surprise would actually be hiking 100bp, something we think is a non-trivial risk. After this week we look for two more 50bp hikes in July and September before the Committee slows to a 25bp hike per-meeting pace until reaching terminal funds at 3.25-3.50% early next year.
Standard Chartered is even more hawkish:
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Neither inflation nor the economy are giving clear enough signals of slowing to deter the Fed from its path of 50bps hikes for the next couple of meetings. We now expect50bps hikes in July (previously 25bps) and 50bps in September (previously zero). We shift our 25bps December2022hike to November and drop our Q2-2023 hike(previously 25bps), leaving us with a terminal rate of 2.75% (previously 2.25%). We do not preclude 75bps and even see an outside chance of 100bps at the 15 June meeting. However, thisis not a Fed that likes to surprise, and the drop in consumer confidence is shocking, so we retain 50bps as our June baseline
1.An article in theWall Street Journal by Nick Timiraos reported that Fed officials are likely “to consider surprising markets with a larger-than-expected 0.75-percentage-point interest rate increase at their meeting this week.” The article is a departure from another article that Nick Timiraos published yesterday that characterized such a move as “unlikely.” Our best guess is therefore that the article is a hint from the Fed leadership that a 75bp rate hike is coming at the June FOMC meeting on Wednesday.
2.We have revised our forecast to include 75bp hikes in June and July. This would quickly reset the level of the funds rate at 2.25-2.5%, the FOMC’s median estimate of the neutral rate. We then expect a 50bp hike in September and 25bp hikes in November and December, for an unchanged terminal rate of 3.25-3.5%.
3.We are also revising our forecast of the dot plot. We now expect the median dot to show 3.25-3.5% at end-2022, the same as our forecast. We expect the median dot to show two further hikes in 2023 to 3.75-4%, followed by one cut in 2024 to 3.5-3.75%.
4.The most likely triggers for a shift to a more aggressive pace of tightening are the upside surprise in the May CPI report and the further rise last Friday in the Michigan consumer survey’s measures of long-term inflation expectations tha thas likely been driven in large part by further increases in gas prices.
5.Over the last month we have argued that market pricing was in roughly the right place in the sense that the drag from tighter financial conditions, in conjunction with the sizeable fiscal drag this year, puts the economy on the somewhat below-potential growth trajectory that we think is needed to rebalance supply and demand. The additional tightening of financial conditions on Friday and Monday, driven by a rise in terminal rate expectations to about 4%, would imply a meaningful further drag on growth that goes somewhat beyond what we think policymakers intend at this point or should be targeting to have the best chance of bringing down inflation without a recession. That is the main reason we have a terminal rate forecast and a probability-weighted funds rate path that are below market pricing.
Good luck with that. Credit event and nasty hard landing dead ahead.