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Fed's Next Rate Hike: What to Expect?

Fed's Next Rate Hike: What to Expect?

Information is not investment advice

The US central bank will lift interest rates at its next meeting on Wednesday, July 27. We'll watch if the Federal Reserve goes with a 75-basis-point or a 100bp hike. Several factors influence the Fed's decision. In theory, the Fed's goal in using a rate hike tool is to tame inflation without causing a recession.

Factors that affect the Fed's decision

To decide on the appropriate rate hike, FOMC members will look at the key inflation metrics such as the Consumer Price Index (CPI) and the indicators of economic growth such as employment numbers to get a better view of the economy.

1. Inflation

The Consumer Price Index (CPI) measures the daily inflation of products and services. The change in this indicator shows how higher/lower prices were during the previous month. Inflation in the US continues to surprise everyone after the last reading came above expectations and jumped to 9.1% in June (the highest level in 40 years), compared to 8.6% in May.

CPI.png

Inflation will continue to heat up and is expected to remain elevated in the coming months. It might prompt the Fed to continue raising rates. However, it won't need to raise rates at a more aggressive pace than the current one. There are tentative signs that inflation might start to calm down relatively, and we are on the cusp of a shift in price growth.

The reasons are lower energy and oil prices. In addition, wage growth has cooled from an elevated level early this year because companies are now halting/slowing hiring to counter the rising prices. With lower commodity prices - particularly food and base metals - price growth may calm slightly.

Gasoline prices are unlikely to continue falling, with the prospect of oil rising again. But a broader decline in commodity prices should help reduce pressures on core inflation.

2. Strong and stable Labor Market

Robust US unemployment data may serve as an argument for the Federal Reserve to raise rates further. Nonfarm payrolls increased by 372K in June, but the unemployment rate remained at 3.6%, defying fears of recession. The June employment report indicates that the US economy is neither on the cusp of recession nor is overheating. 

NFP.png

However, despite the strong US labor market, the Fed won't risk accelerating rate hikes, fearing that efforts to contain inflation, if excessive, will lead to a recession and a sharp increase in unemployment. Raising rates may cause a slowdown in the economy and will likely lead to increased unemployment over time.

When will the Fed raise rates? And by how much?

Bets to hike rates by a whole percentage point increased after inflation in America surged to 9.1%. Higher rates should cool the raging prices. However, concerns about the impact of rate hikes on the US economy may limit the rate increase by 75 basis points.

Overall, the market is ready for a 75-point hike. If the Fed signals slower rate increases in the future, the USD may slip versus other major currencies, while the US500 will get a boost.

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