SINGAPORE/NEW YORK — Rising expectations that the Federal Reserve will raise benchmark interest rates by 75 basis points this week unsettled global investors Monday and fueled steep declines in both U.S. stocks and bonds.
The Federal Reserve meets on Wednesday in the midst of heavy selling in stock and bond markets following May data showing U.S. consumer prices rising at their fastest pace since 1981. A 75 basis point hike would be the biggest since 1994.
CME’s FedWatch tool, based on the prices of short-term credit futures, shows a 30% chance of a 75 basis point rate hike at this month’s meeting, up from a 3.1% chance seen one week ago.
“The May inflation data was so concerning that we think the Fed will react even more aggressively in moving rates ‘expeditiously’,” BNY Mellon strategist John Velis said on Monday. His note forecast a 75 basis point hike on June 15, up from an earlir 50 basis-point prediction.
“We felt compelled by circumstances to change our view.”
Barclays and Jefferies also forecast a 75 basis point hike for this week.
“US CPI surprised to the upside and continues to show broad and persistent price pressures,” Barclays analysts said in a Sunday note. “We think the Fed probably wants to surprise markets to re-establish its inflation fighting credentials.”
The S&P 500 appeared on track to confirm a bear market on Monday, while a widely watched part of the Treasury yield curve inverted on fears that big Fed hikes would tip the economy into recession. Yields of benchmark 10-year Treasuries, meanwhile, hit their highest levels since 2011.
“The markets are not waiting for Wednesday’s meeting, they are going to front run them and that’s what is already happening in the markets today,” said Jim Paulsen, chief investment strategist at the Leuthold Group.
Other large investors on Wall Street said that while they do not see a 75 basis point move as imminent, the probability of such a large rate hike in the next few months are rising.
“Our baseline is that the Fed delivers 50 bps this week and will try to set up an option for 75 bps in July, but if the market prices in a higher risk of 75 bps over the next few days, we think this will give the Fed an opportunity to be more aggressive on Wednesday,” analysts at Pacific Investment Management Co (Pimco) wrote Monday. “We expect Chair Powell to use the press conference to signal larger hikes are back on the table and that they are not slowing down in September.”
Standard Chartered said in a Monday note that while it expected a half-point rise this week, it did not preclude larger increases of 75 basis points or even a full percentage point.
It upgraded its forecasts for July and September to a 50 basis point and a 25 basis point increase, respectively, from previous expectations of 25 basis points in July and zero in September.
Markets have reacted too, with a selloff in short-dated Treasuries along with futures tied to the Fed policy rate extending in Asia on Monday. Yields on the two-year Treasury note are at their highest since late 2007.
In one sign of turmoil in the global fixed income market, credit default swap indexes measuring the cost of insuring against European corporate bond defaults jumped on Monday to their highest since 2020.
Bets on the U.S. terminal rate – where the Fed funds rate may peak this cycle – continue to rise. On Monday, rates were priced to approach 4% in mid-2023, up almost one percentage point since end-May. Deutsche Bank said it now saw rates peaking at 4.125% in mid-2023.
For Rabobank, the risk of ‘stagflation’ – a period of weak growth and high inflation last seen in the 1970s – could give way to the threat of ‘incession’, a combination of inflation and recession, it said in a research note on Sunday. (Reporting by Tom Westbrook, Davide Barbuscia and David Randall; Editing by Bradley Perrett, Megan Davies and Tomasz Janowski)