Recent CPI Spike Creates Outside Chance Of Triple Fed Hike On Wednesday

Based on April’s inflation data, it was possible to argue that U.S. inflation had peaked and the Fed might actually soften planned future rate hikes. However, May’s inflation spike questions that assessment.

The issue now for financial markets is well beyond if the Fed will raise rates or not. It’s whether the Fed might go even larger with a potential June rate hike.

The Fed may well opt for a ‘double’ hike raising rates 50bps, as expected before May’s CPI inflation data was released. However, with the worrying May inflation report a ‘triple’ hike raising rates 75bps is now possible.

Market Expectations

The CME’s FedWatch tool, which tracks market expectations for rate movements gives roughly a 80% chance of a 50bps move and a 20% chance of a 75bps move. As such as 50bps is still the most likely outcome, but a 75bps move is not yet off the table.

The fact that recent jobs data has been reasonably robust, strengthens the Fed’s hand in raising rates, though other signals are becoming more mixed. The Fed are worries, primarily, that raising rates could hurt the U.S. job market, so far unemployment has held at 3.6% over recent months. However, as a consequence of the Fed’s plans, the housing market may be cooling as mortgage rates have increased dramatically higher since last fall. Still the Fed’s main priorities are unemployment and inflation – not the housing market, even though it’s clearly related.

May’s Inflation Data Was Bleak

There was little to reassure the Fed that inflation was coming under control in the May’s CPI Report. Inflation rose 1% month-on-month. That’s a bigger move than all recent months except March. Furthermore, headline inflation is now running at 8.6% year-on-year.

Stripping out food and energy doesn’t help much, prices still rose 6.0% year-on-year after that adjustment. However, one positive is that inflation less food and energy may suggest that price increases are slowing.

Peak Inflation?

May’s annual rise in prices less food and energy was still lower than April, which was in turn below March. Maybe that trend will stay intact. Energy prices continue to be the main driver of the current bout of global inflation, though there are also concerns that inflation is spreading to many other products and services.

The Fed likes to also look at PCE inflation data, but we won’t have that data for May 2022 until June 30, well after the Fed meeting for June has concluded.

Still, the Fed does like to stick to the script and expectations have been managed for a 50bps rate increase on Wednesday. Doing more may create some shock and awe about the Fed’s commitment to fighting inflation, but may come at the cost of hurting the Fed’s reputation for carefully managing the markets’ expectations.