In the last 24 hours, investor expectations for the Federal Reserve have coalesced around a 75 basis point hike, nudged in that direction by a Wall Street Journal article.
Fed-funds futures markets now see an overwhelming likelihood of a 75 basis point move, which would be the biggest rate hike in almost three decades. Investors see only a 3% chance of a smaller 50 basis point move.
In early May, Fed Chairman Jerome Powell said that officials had settled on a plan to raise its policy rate by 50 basis points on Wednesday and again at the next Fed meeting. In their speeches of the last six weeks, officials seemed content with the plan.
The sudden shift in expectations caught many economists by surprise. Even with a sharp rise in consumer prince inflation in May, along with a rise in inflation expectations, economists thought the Fed would hike by 50 basis points and talk hawkish.
“Powell worked very hard to get the divergent committee on board” the plan for three straight 50 basis point moves, said Vince Reinhart, a former top Fed staffer and now chief economist at Dreyfus and Mellon.
As a result, Reinhart still thinks there is a “higher chance than currently in markets” for a 50 basis point move Wednesday.
“They had a plan and might still stick to it,” he said.
Rubeela Farooqi, chief U.S. economist at High Frequency Economics agreed.
“Our baseline view remains that the Fed will hike the target range by 50 basis points, Farooqi said.
Why a larger move?
Bill English, who was also a top Fed staffer and is now a professor at the Yale School of Management, thinks a larger move would be the Fed “stamping its foot “to stress it is not prepared to live with higher inflation.
Joe Gagnon, another former Fed staffer, and now a senior fellow at the Peterson Institute for International Economics, said the 75 basis point hike, if enacted, would be designed to get people’s attention and potentially change their behavior.
If the Fed seems poised to stamp on the brake of the economy , the likelihood of a recession will rise.
In that environment, business executives might think twice about raising prices in an environment of higher recession risks, Gagnon said.
In the wake of The Wall Street Journal article, investors in the fed funds futures market now see the Fed hiking its benchmark policy rate up to 4% by next summer.
Stocks DJIA, -0.50% SPX, -0.38% were lower Tuesday but only by relatively small moves compared with Monday’s steep sell-off. The yield on the 10-year Treasury note TMUBMUSD10Y, 3.393% jumped to 3.465%, after hitting an 11-year high the previous session.