Stocks fell through noon after opening slightly higher this morning. Yesterday, all three major indexes plunged in anticipation of a more hawkish than expected Fed, which began its June FOMC meeting this morning.
The meeting wraps up tomorrow afternoon, and, following revised estimates from Wall Street, investors seem to believe that a 75 basis point (bps) rate hike is on its way, up from prior estimates of just 50bps.
The reason being that the May Consumer Price Index (CPI) rose 8.6% year-over-year, beating March’s gain of 8.5%. This effectively killed the “peak inflation” narrative and forced traders to adjust their expectations simultaneously on Friday when the CPI was released.
Analysts say Fed Chairman Jerome Powell has plenty of evidence now to support a more hawkish stance moving forward. Goldman Sachs, for example, put out a note predicting two 75bps rate hikes in June and July followed by a 50bps increase in September. November and December will see two additional hikes of 25bps, Goldman argues, bringing the fed funds rate to 3.25%-3.5% by the end of the year.
That’s up significantly from 2.5%, which investors assumed was the Fed’s target rate after the May FOMC meeting minutes were released late last month. The Fed saw inflation moderating to 2.5% in 2023 according to the minutes.
In light of the May CPI reading, however, the Fed’s projections may have changed.
Evercore ISI’s central bank strategist, Krishna Guha, observed that without clarification from the Fed, “we are forced to take the reports at what we think is face value: it looks like we were wrong and 75 is after all likely this week. We repeat that we think this is not optimal policy and would separately be bad for markets.”
Guha believes the Fed should go with a softer hike. The majority of skeptical, off-Wall Street analysts (myself included) think that the Fed should raise rates faster. Keep in mind that earlier this year, most of the big banks thought a fed funds rate around 2.00% would be enough to stop inflation. The Fed viewed it that way, too.
Before that, neither Wall Street nor the Fed believed inflation would spiral out of control. Remember when Powell and Treasury Secretary Janet Yellen used to say elevated inflation was merely “transitory?”
Over the last few weeks, both Powell and Yellen have finally admitted that they were wrong. Wall Street strategists, meanwhile, still primarily believe the Fed should hike but also keep a door open for future dovishness.
Tomorrow’s assumed hike of 75bps screams “policy error” to them.
And, over the last 12 hours, every bank told their clients that a 75bps hike is virtually guaranteed. It’s no surprise that stocks tanked yesterday and failed to rally this morning.
A 75bps hike has effectively been priced in already.
That means, tomorrow afternoon, the odds favor a major post-FOMC melt up. The only way that stocks head even lower is if Powell shows up to announce a massive hawkish surprise, like a 100bps hike.
Anything at 75bps or less would ease the fears of many a market bull, meaning that bears who are currently short may want to take already substantial profits tomorrow morning, even if that means missing a shot at bigger returns on a rate hike “dice roll” later that afternoon.