The U.S. Federal Reserve raised its target Fed funds rate by 0.75% in June and July in an attempt to get inflation under control.
Investors wondering if the Fed will pull the trigger on a third 0.75% hike at its next meeting this week got some key inflation data last week suggesting the Fed may even ramp up the pace of its tightening this month.
Last Tuesday, the U.S. Labor Department reported an 8.3% rise in the consumer price index in August, exceeding economist estimates of 8% inflation. Following the release of the CPI number, the Dow Jones Industrial Average dropped by 1,276 points, its worst day since June 2020.
Big Rate Hike Coming: In response to the cooler inflation number, the bond market is now pricing in a 100% chance the Fed will raise rates by at least another 0.75% on Wednesday, according to CME Group. Investors are pricing in an 80% chance of a third 0.75% rate hike and a 20% chance the Fed will get even more aggressive with a 1% rate hike this week.
Quincy Krosby, chief global strategist for LPL Financial, said investors should brace themselves for another volatile week of trading with the Fed meeting looming.
"Every word will be parsed for deeper meaning by the algorithms that move nearly instantaneously, that are then joined by the global coterie of traders and investors alike. As the S&P 500 hovers below the all-important 3,900 level, and the 10-year Treasury yield inches ever closer to 3.5%, the Fed-sensitive 2-year Treasury note flirts with 3.9% suggesting that the Fed's aggressive campaign to kill off inflation is to be taken seriously," Krosby said.
More Rate Hikes Coming: One month ago, the bond market was pricing in a 0.5% rate hike, but the latest inflation numbers now have investors convinced that the Fed will be more aggressive. Investors are also expecting interest rates to continue to rise through the end of the year.
The market is now pricing in a 57.4% chance the fed funds target rate range will be 4.25% to 4.5% or higher by the end of 2022. Only one week ago, those chances were 2%.
Jeffrey Roach, chief economist for LPL Financial, said Friday that resilient consumer sentiment trends suggest the Fed is navigating the difficult situation well up to this point.
"The Fed may achieve its goal of a 'Goldilocks' soft landing as consumer demand is neither too hot nor too cold. Consumers are showing amazing resiliency as buying conditions for major ticket items are better than the June lows but still look weak," Roach said. "If energy prices continue to fall, then I expect that we’ll see inflationary data coming down in future months."
Benzinga’s Take: Inflation may have finally peaked, but interest rates will most certainly continue to rise until inflation falls back down near the Fed's long-term target rate of 2%.
Last week's bearish action in the SPDR S&P 500 ETF Trust SPY suggests investors are growing increasingly skeptical that the Fed can successfully bring down inflation without triggering a U.S. Recession.
Yields on two-year Treasury bonds gained another 0.1% on Monday and are now at multiyear highs of 3.96%, further pressuring the slumping stock market. The yield on 10-year Treasuries even briefly eclipsed 3.5% for the first time since 2011.
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