Why A 1% July Interest Rate Hike May Be Off The Table

Zinger Key Points
  • Bank of America's Michael Gapen says the latest inflation and labor market data clearly indicates the U.S. economy is overheating.
  • Yet there are also mixed signals on the economy when it comes to activity.
Why A 1% July Interest Rate Hike May Be Off The Table

The U.S. Federal Reserve raised its target Fed funds rate by 0.75% in June, its first interest rate hike of that size since 1994.

With this month's Federal Open Market Committee meeting just around the corner, investors are still debating whether the Fed will opt for another 0.75% rate hike or go even more aggressive with a full 1% hike.

If the Fed opts for a 1% rate hike this month, it will be the largest interest rate hike in more than 30 years.

Earlier this month, the Labor Department reported the consumer price index (CPI) gained 9.1% in June, the highest inflation reading since 1981.

Related Link: The Market Is Now Pricing In a 1% July Interest Rate Hike Following Red-Hot CPI Inflation Reading

On Wednesday, Bank of America economist Michael Gapen said the latest inflation and labor market data clearly indicates the U.S. economy is overheating. Yet there are also mixed signals on the economy when it comes to activity. The latest data suggests the housing market has started to roll over and manufacturing production is softening.

In Their Own Words: Gapen said the Fed is likely to prioritize inflation for the time being, but there is at least some evidence it will opt to stick with a 0.75% hike in July. He said Fed members tend to prepare financial markets for unexpected rate changes via commentary leading up to the roughly two-week public blackout period prior to an interest rate decision.

"If the Fed were inclined to lift rates by 100bp in July, we think it would likely have signaled its intent prior to entering the blackout period last week, particularly since financial markets had already priced in a larger move," Gapen said.

Related Link: An ETF To Protect Your Portfolio? Goldman Sachs Has a Product For

Earlier this month, the bond market was pricing in a greater than 50/50 chance of a 1% rate hike this month, according to CME Group. Today, the market is pricing in just a 30.9% chance the Fed will raise rates by 1% in July.

Benzinga’s Take: Rising interest rates are certainly no cause for investors to panic and dump all their long-term stock holdings just because there may be more volatility in the SPDR S&P 500 ETF Trust SPY in coming weeks. Investors should consider holding an elevated level of cash for the time being to allow for investing flexibility if the Fed triggers an even steeper sell-off in stocks.

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