Traders Bet the Fed Will Announce Smaller Interest Rate Hike as Economic Signals Weaken

Federal Reserve Chairman Jerome Powell speaks during a news conference on interest rates, the economy, and monetary policy at the Federal Reserve Building in Washington on June 15, 2022. Olivier Douliery/AFP via Getty Images

Investors are increasingly betting on a 75-basis-point hike by the Federal Reserve at its July meeting, after almost two-thirds had predicted an increase of 100 basis points only a few days prior.

During the week starting July 11, the markets briefly anticipated that the central bank would raise interest rates by a full percentage point.

According to CNBC, economists are now expecting the Federal Open Market Committee (FOMC) to proceed with the smaller policy option by raising interest rates by three-quarters of a percentage point at its meeting on July 26–27.

Central bank policymakers admitted that they were comfortable raising rates by 75 basis points at the upcoming meeting, but still left the door open for a larger hike.

If the Fed makes the anticipated 75-basis-point move, the benchmark overnight borrowing rate will hit a target range of 2.25–2.5 percent, where it has not been since late 2018.

“This softening of inflation expectations is one reason why we expect the FOMC will not accelerate the near-term hiking pace and will deliver a [75-basis-point] hike at the July FOMC meeting,” Goldman Sachs economist Ronnie Walker said in a note.

Recent comments by key Fed officials, including St. Louis Fed President James Bullard and Atlanta Fed President Raphael Bostic, led most futures traders to bet on a 75-basis-point hike, the same rate increase enacted by the Fed at its June meeting.

The public statements by key central bank policymakers caused the U.S. dollar to fall to a one-week low against a basket of currencies on July 18, after reaching a two-decade high the previous week.

The University of Michigan’s preliminary July survey of consumers, released on July 15, is closely watched by the Federal Reserve board. The university’s June report was a factor in determining that month’s large interest rate hike.

The University of Michigan’s July survey showed inflation, as viewed by consumers, running at 2.8 percent over a five-year horizon, a drop from 3.1 percent in June.

The new report from the Labor Department on July 13 showed consumer prices rising to an annual 9.1 percent pace in June, which led to the recent anticipation of a 100-basis-point rate hike.

However, analysts are saying that the central bank is dealing with a slowing economy and with inflation that now appears to be showing signs of peaking, if not beginning to decline.

About 66 percent of traders in futures contracts tied to the Fed’s short-term federal funds policy rate shifted their bets to the lower 75-basis-point hike, while those betting on the higher rate were at 33 percent.

The dollar saw further pressure after a July 18 report from the National Association of Home Builders showed American homebuilder sentiment tumbled to its lowest level since mid-2020 due to the high inflation and mortgage rates.

The report showed builder sentiment falling from 67 to 55 in July, a sign that the housing market is cooling down.

An inversion between the 2-year and 10-year Treasury yields has indicated that a recession is on the horizon.

Two-year Treasury notes, which are now at 3.17 percent, suggest that the Fed may be taking a less aggressive policy, with futures pricing predicting a terminal federal funds rate of 3.55 percent in early 2023.

The dollar index fell to 107.32 on July 18 after closing at a two-decade high of 108.65 on July 14.

Reuters contributed to this report.