GON´T BUY THE HYPE. THE FED IS UNLIKELY TO DO A FULL-POINT RATE HIKE / BARRON´S MAGAZINE

Don’t Buy the Hype. The Fed Is Unlikely to Do a Full-Point Rate Hike.

By Lisa Beilfuss

Fed chief Jerome Powell, shown testifying at a Senate hearing in June, faces a slowing economy ahead of the central bank’s July 26-27 meeting./ Will McNamee/Getty Images

Many economists and investors convinced themselves during the week that the Federal Reserve would supersize the latest supersized rate hike and raise interest rates by a full percentage point this month. 

That’s probably a bad bet, and it doesn’t end there.

Behind the frenzy was yet another hot inflation report. 

The June consumer-price index rose 9.1% from a year earlier, a fresh 40-year high that again blew out Wall Street’s expectations. 

The report was categorically bad. “At this point, it’s not plausible to blame just supply restrictions or the war in Ukraine for high price increases—the problem is broader than that,” says Roberto Perli, head of global policy at Piper Sandler . 

“The Fed knows it as well.”

Traders swiftly repriced Fed expectations, betting on a significant chance of a full percentage-point rate increase when the central bank ends its July 27 meeting. 

Plenty of economists did the same. 

“We now expect the Fed to deliver a 100 [basis-point] rate hike at its meeting later this month,” economists at Citi group wrote in a note to clients Thursday, a day after the latest CPI report.

Citi pointed to Fedspeak during the week as supporting evidence. 

Neither Atlanta Fed President Raphael Bostic nor Cleveland Fed President Loretta Mester pushed back on a potential full-point hike, with the dovish San Francisco Fed President Mary Daly suggesting a 0.75-percentage-point increase is the new half-point hike. 

Fed governor Christopher Waller left open the door to a bigger move this month. 

The board of governors represents the Fed’s leadership, and Waller said his view depended on retail sales and coming housing data.

Investors on Friday got the retail sales report Waller referenced. 

Some read it as underpinning the case for an even bigger Fed move this month, with sales on their face beating expectations and prompting many to blow off mounting recession signs such as rising layoffs and unexpected increases in banks’ loan-loss provisions. 

When you adjust the data for inflation, retail sales fell again in June, says Ed Yardeni, president of Yardeni Research

The bigger policy clue came later on Friday. 

Fed officials indicated a substantial increase in the University of Michigan’s five-to-10 year inflation-expectations gauge spooked them enough in May to throw out guidance and hike rates by 0.75 percentage point. 

That figure was later revised lower, to a still-elevated but less-alarming 3.1%. 

Then the preliminary July reading came in at 2.8%, the lowest in about a year. 

While that’s subject to revision, it wouldn’t happen before the next rate decision.

A fall in longer-term inflation expectations doesn’t negate the ugly June CPI or, as Richard Curtin, director of the Michigan survey says, “the deleterious effect” of rapidly rising prices on households’ personal finances. 

But it probably does take a one-percentage-point rate hike off the table.

It also means we have probably seen peak hawkishness, if not peak prices. 

Lost in the debate over the size of the July hike is the growing bet that tightening will end sooner. 

Nick Reece, strategist at Merk Investments, notes eurodollar futures suggest rates will peak in December. 

Two months ago, the bet was on rates topping out in June 2023.

While some economists are predicting an ever-more aggressive Fed, strategists at Bank of America said this week they believe the Fed will start cutting rates in September 2023. 

BofA’s Mark Cabana and his team also predict quantitative tightening, or balance sheet shrinkage, will end at the same time—translating to about a trillion less in tightening than markets expect.

Traders walked back the 100 basis-point bet on Friday, but not by enough. 

There is still room between what many economists and traders expect—in July and beyond—and what the Fed will actually do.