Investors reversed bets on a full percentage-point move after wary comments from officials including Atlanta Fed president Raphael Bostic and St Louis’s James Bullard, plus rare good news on inflation.
Shortly after they both spoke on Friday morning, data showed US consumers’ long-term inflation expectations declined in early July by more than forecast to 2.8 per cent, versus 3.1 per cent the month before.
Interest-rate futures contracts currently imply a roughly one-in-six chance that the Fed will increase rates by a full point this month, with a 75 basis-point rise regarded as a certainty.
“Based on what I have heard, absent the most important voice at the table, there seems to be a rally around 75 basis points” of tightening in July, said Mark Spindel, chief investment officer at MBB Capital Partners, referring to chairman Jerome Powell.
The remarks at separate events on Friday by Mr Bostic and Mr Bullard were the latest from officials to signal support for a 75 basis point move, which Mr Powell told reporters last month was on the table for July.
The Fed in June raised the federal funds rate target by 75 basis points — the biggest rise since 1994 — to a range of 1.5 per cent to 1.75 per cent, after previously signalling it would increase by 50 basis points.
Officials regard another 75 basis points as a powerful jolt to the economy, and are keeping an eye on how their policies are affecting growth. Housing markets appear to be cooling and there are scattered signs that consumption is levelling off.
“The real side looks to be softening. You don’t want to really overdo the rate hikes,” Fed governor Christopher Waller said on Thursday.
“A 75 basis point hike is huge. Don’t say because you are not going 100, you are not doing your job.”
At the same time, officials are watching carefully how gauges of inflation expectations are behaving.
Longer-term market measures have come down in recent months, precisely because the Fed has delivered on aggressive policy, and officials understand that they have to continue to deliver if they are going to keep those expectations anchored around their 2 per cent target.
“Inflation expectations are determined not only by movements in inflation, but also by policymakers’ actions to follow through on their strongly stated commitment to return inflation to its longer-run goal — thereby justifying the public’s belief in the central bank’s commitment,” Cleveland Fed chief Loretta Mester said in a speech on June 29.
What it all means is that if inflation remains high — putting expectations at risk — the Fed is signalling it will not hesitate to step harder on the policy brakes, even if that hurts the economy.
Traders boosted bets on a 100 basis-point increase earlier in the week after June’s consumer price index came in at a 9.1 per cent annual gain. Those bets retreated on Friday.
Mr Bostic, speaking in Tampa, Florida, said he was wary of the bigger rate increase because “moving too dramatically I think would undermine a lot of the other things that are working well”.
He also said that he had a “Go Big” group in his bank, and “every time we get to a meeting, they are like, ‘We should just go, go, go.’ I am not in that group today”. Mr Bostic does not vote on policy this year.
Mr Bullard was quoted earlier this week as saying he favoured sticking with a 75 basis point rate move. He declined to declare himself on Friday, but said he backed raising rates to a range of 3.75 per cent to 4 per cent by the end of the year, rather than 3.5 per cent.
That implies about 2.25 percentage points of tightening from current levels. Mr Bullard is a 2022 policy voter.
“I still don’t think they’ll do 100” basis points this month, said Derek Tang, an economist at LH Meyer, a Washington policy analysis company.
“It’s a close call, but it’s tactically unsound. How would they justify a downshift to 50 or 75” if inflation remains high.
Data between now and the meeting include more information on the health of the housing market, among other things, and some still see a risk of a larger move.
“There is still a lot of time between now and the July meeting. Everything is on the table,” said Lindsey Piegza, chief economist at Stifel Nicolaus & Co.
“At the very least, we see a 75 basis-point hike. But I think there is a realistic possibility of a 100-basis point move.”