The Fed is going to hike rates by at least 75 bps. Here's why

21.07.22 03:46 PM By Cullen

When a Dual Mandate Becomes a Single Mandate, Talk of 50bps is folly

 The Fed Decision is within hours.

 

In recent weeks, there has been some exuberance in the stock market, as a few economic indicators suggested that perhaps the Fed wouldn’t tighten as much as the anticipated 75 bps hike.  Most recently, we’ve seen better-than-feared earnings from the likes of Google, and encouraging guidance from Microsoft, which has caused a small pop today across the tech sector.

 

Our view is that we should expect another 75 bps hike, and that the likelihood of any variance from that is more likely to be a 100 bps hike than a 50bps hike. 

 

It was just about a little more than a week ago where traders were betting that the Fed could raise interest rates by a full percentage point.  However, on the heels of that, we got some news out of the University of Michigan that in fact we've seen a drop in the expectations around inflation moving forward and overall increase in consumer confidence. 

 

This led to a major surge in stock prices since July 13th.

 

However, let’s take a moment to really consider what the UofM data really means. 

 

The UofM data specified that consumers expect inflation to go down.  Expectations over the next year were 5.5 percent, and now are 5.2 percent.  Consumers are feeling more confident that inflation will get under control.  That’s it.  It’s more a statement on confidence in the Fed, regression to the mean, or the impacts of a recession than it is a statement of confidence that inflation is going away very soon.

 

Fact of the matter is that the Fed has a dual mandate to a) keep unemployment low and b) control inflation.  Beyond that, we’d argue, the Fed also has an implied mandate to maintain its legitimacy.  All three of those factors are pointing a single direction – a big rise in rates.  Inflation is around 9%. Unemployment is at levels not seen since the 1960s (3.6%).  And many made the declaration that “the Fed has no credibility when it comes to battling inflation.” 


Add those three things together and you’re going to see a 75bps hike.  We frankly see more than enough justification for a 100 bps hike, but given the Fed’s predisposition toward avoiding surprises, we expect we’d have seen a few leaks as a trial balloon to prime the market.  We haven’t seen those in a substantial way.

 

So 75bps hike.  A small chance of 100bps.  Mark it down.  And expect further hiking as we move forward.  The bigger question is whether the Fed’s actions actually have sway over enough of the market to bring its inflation metrics under control.  That’s a discussion for another post.

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