Despite Bear Market, Fed Expected To Hike Aggressively Next Month

Despite many indices now in bear market territory and bonds falling too, the Fed still appears on course for a double-sized or even triple-sized hike next month according to market futures. It seems economic data has a better chance of changing the Fed’s trajectory than swings in the markets.

June Hike

Future’s markets according the the CME’s FedWatch tool have the Fed upping rates by 50bps to 1.25%-1.5%, with a one in ten chance of a 75bps hike. These are larger moves than the Fed’s typical 25bps adjustment to rates, signaling the Fed are serious about controlling inflation.

And Beyond

That that’s expected to be followed by potentially another 50bps move in July and 25bps increases in each of the remaining 2022 Fed meetings again based on market futures. That would have the Fed Funds rate ending the year at a little under 3% compared to just under 1% currently. The last time that the Fed had rates above 3% was in early 2008, then rates were on their way down rather than up, just prior to the Great Recession.

Data Dependence

However, the Fed is very data dependent in its decision making. A recession is not part of the Fed’s plan, and it is a scenario that the stock market is increasingly concerned about. So might the Fed change course?

Inflation

We’ll see another inflation report on 10th June, the week before the Fed meets and that may shed light on whether March saw peak U.S. inflation, and more importantly, what core inflation in the U.S. looks like over the medium term. Many expect inflation to moderate from current levels of over 8% currently, but the Fed’s target for inflation is 2% so the concern is that even if inflation falls, it won’t fall enough without aggressive Fed action. Hence those big potential rate hikes.

Unemployment

The other major indicator the Fed will be watching is unemployment. Currently, unemployment is at the very low level of 3.5% for the U.S.. This gives the Fed comfort that it can raise rates without the economy hurting, for now.

However, anecdotally Netflix
NFLX
has made small layoffs and Meta and Snap plan to slow hiring. These are hardly signs that the hot jobs market will go into reverse. For example, Intel is relaxing its hiring rules in an effort to find workers. Still this is something that the Fed will be watching closely. If the job market turns, then they may feel less confident in raising rates so aggressively.

Valuations

There were a number of signs that U.S. stocks in particular were at relatively lofty valuations compared to history, so the Fed may not worry about the falling stock market as much as it might. Especially with U.S. inflation over 8%.

Nonetheless, if the stock market fall does have knock on effects for the real economy and starts to slow down the job market, then the Fed may adjust its course. For now, there aren’t many signs of that, though there are still some important data releases to come before the Fed meets next month. The falling stock market implies that some of that data may be less good than hoped.