Hotter inflation and inflation expectations data could see markets grappling with the risk of a 1-percentage-point increase.
Federal Reserve officials are likely to support repeating June's aggressive 0.75-percentage-point interest rate increase in July and possibly again in September to tackle inflation that is showing little sign of slowing, former officials told MNI.
An even larger 1-pp hike cannot be ruled out if inflation or inflation expectation trends worsen, the former officials said, though the FOMC is likely to shy away from adding to an uncertain environment with yet another alteration to its policy path.
"I believe they’ll do 75 in July because they’ll need a very good reason not to. There’s not a great deal of new inflation information coming in between the June and July meetings," former Atlanta Fed President Dennis Lockhart said in an interview. "They feel pretty good about how the 75 was absorbed at this last meeting, so there is some bias for not making one more change and being steady with 75 through the July meeting."
Rick Roberts, a former New York Fed executive and ex-Kansas City Fed adviser now at Monmouth University, told MNI's FedSpeak podcast: "I suspect that 75 bps is the new baseline that we’ll be looking at for the next couple of meetings. Going far beyond even the next meeting is tough in this environment with ever-changing data."
Roberts added he could envision some negative data that would lead the Fed to upsize its July hike to 100 bps, but "I would still be surprised."
"If you’d asked me a few months ago I would have said no way. Less certain of that now. The Fed seems more than ever data-point driven," he said.
Fed Chair Jerome Powell has set a high bar for slowing from the fastest pace of tightening in decades, saying the FOMC is looking for several months of consistent month-on-month improvement in headline CPI and PCE inflation, as well as in various internal measures of underlying inflation like the Dallas Fed Trimmed Mean measure, and key consumer inflation expectations indicators.
But core services prices, which tend to be sticky and closely connected to overly tight labor markets, have continued to climb at an 8% annualized rate over the past three months as consumers pivot back to services spending. Rent and owners' equivalent rent in May hit their highest since the late 1980s and early 1990s, and housing experts told MNI they are unlikely to decline much for months more. (See MNI INTERVIEW:Housing Cost Lag To Drive Inflation As Fed Hikes)
RISK OF OVERTIGHTENING
One potential path that would take the fed funds rate to the FOMC's projection of 3.4% by the end of the year is a 75 bp increase in July followed by 50 bps in September and 25 bp hikes in November and December.
"Somehow they've got to start framing expectations that you can't move 75, you can't move 100, you can't even move 50 forever. Pretty soon you have unreasonably high rates," said Nathan Sheets, former international finance division director at the Fed Board and now global chief economist at Citi.
An inflection point might come after the July meeting, when rates breach the FOMC's median estimate of the longer run fed funds rate at 2.5%, but before inflation returns to more normal levels.
"If they are going to hike until headline inflation actually falls, there's a distinct risk that that means we're being reactionary and they overtighten," Sheets said. "I understand that they want to see a better inflation story, but headline inflation falling deeply could lag."