FOMC preview: Surprise 100bp hike a possibility as inflation stands at 40 year high

The Federal Open Market Committee (FOMC) continue the central bank theme this week, with the trading community widely expecting another oversized rate hike from Powell & co. Inflation continues to be the key concern, with markets keen to understand the pathway for rates given the recession risks that loom large. The two-day meeting concludes on Wednesday 27 July 2022.

Inflation forces their hand, despite growing recession fears

Inflation continues to provide the Federal Reserve (Fed) with a major obstacle that needs to be resolved before wage hikes cause a cost-push inflationary spiral that drags out this crisis. With headline consumer price index (CPI) currently at 9.1%, we are seeing prices rise faster than any time over the past 40-years. However, while rates stood at 13% when inflation stood at 9.5% in November 1981, rates now stand at just 1.75%.

That being said, with gasoline prices retreating, we are seeing divergence between the core and headline inflation. This could help ease pressure on the Fed to push rates as quickly. Nonetheless, with all forms of inflation still elevated, we should get used to the idea of further rate hikes.

The jobs picture remains a key area to follow, with some initial warning signs emerging as price pressures take their toll. The Conference Board ratio between those that find jobs hard to find compared with those that see employment opportunities plentiful has started to turn upwards. We are similarly seeing unemployment claims start to turn upwards. These two provide initial warning signs that we could see unemployment push higher in the not-too-distant future.

What to expect from the Fed

The Fed are expected enact yet another 75-basis point (bp) rate hike on Wednesday, taking the headline interest rates to 2.50%. It has been an incredible journey thus far this year, with elevated inflation forcing the Fed to shift rates 150 bp over just three-meetings. This trend is expected to continue, with markets pricing an 87% chance that the Fed will raise rates by 75 bp. However, one notable trend we have seen from central banks has been the willingness to push rates at a faster rate than many expect.

Throughout the past two-months, we have seen the Fed, Reserve Bank of Australia (RBA), Swiss National Bank (SNB), Bank of Canada (BoC), and European Central Bank (ECB) all hike more than expected. The growing expectations of an impending recession do appear to provide a willingness to act sooner rather than later. With that in mind, perhaps the 13% expectations of a 100 bp move could be underpriced.

Traders should keep a close eye out for Powell’s commentary that follows the initial announcement. With inflation and recession fears on the rise, this segment of the event should help provide greater clarity over the outlook for rate going forward. Powell’s perspective around growth and inflation risks will be key here, for any decision to focus on one over the other would bring an idea over whether we will continue to see this rate trajectory maintained or slow.

Dollar index technical analysis

The dollar has enjoyed a strong year thus far, with the index rising into a 19-year high this month. We have seen the greenback drift lower heading into this meeting, with some speculating that much of the forthcoming rise in rates has been priced in. However, it seems likely that the US economic decline will be significantly less dramatic than those in Europe given their proximity to Russia.

Thus, we are likely to see the Fed hike rates well over and above levels seen under the ECB. Meanwhile, there are some countries such as Japan which continue to keep rates low in the absence of critical levels of inflation. With that in mind, further upside seems likely for the index, with price turning higher today. A break below the 103.19 level would be required to bring about a more bearish outlook. Until then, this recent pullback looks to be temporary in nature as we prepare for another push higher.