Fear of Expected Inflation Worse Than Inflation... Fed Contemplates 'Giant Step' Move

[Asia Economy New York=Special Correspondent Joselgina] Until just a few days ago, the so-called ‘Giant Step,’ which involves raising interest rates by 0.75 percentage points at once, was considered an unlikely option. The sudden shift in sentiment on the 13th (local time), a day before the start of the Federal Open Market Committee (FOMC) meeting of the U.S. Federal Reserve (Fed), is due to persistent inflation that refuses to be controlled. Despite consecutive rate hikes, inflation shows no signs of easing, leading to the assessment that the Fed is resorting to a ‘shock therapy.’

◇Giant Step Gains Momentum... CNBC: "A Real and Clear Possibility"

The Giant Step option gained traction recently as the U.S. Consumer Price Index (CPI) for May rose 8.6%, the highest since December 1981. Additionally, inflation expectations among U.S. consumers for the next year reached an all-time high, amplifying voices that a ‘Big Step’ (0.5 percentage point hike) is insufficient. According to the New York Federal Reserve Bank, the expected inflation rate for the next year in the May consumer outlook survey rose by 0.3 percentage points from the previous month to 6.6%. This confirms through data that inflation is expected to remain at a high level for the foreseeable future.

This immediately strengthened expectations for aggressive Fed tightening. Following investment banks Barclays and Jefferies Group, which mentioned the possibility of a Giant Step right after last week’s CPI release, JPMorgan Chase and Goldman Sachs also joined the ranks. Local media such as The Wall Street Journal (WSJ), CNBC, and The New York Times (NYT) all reported on the possibility of a Giant Step.

The WSJ reported, "Due to a series of troublesome inflation reports recently, the Fed is considering surprising the market with a larger-than-expected 0.75 percentage point hike at this week’s FOMC." This marks a sharp turnaround from just a day earlier when a 0.75 percentage point hike was viewed negatively. CNBC also described it as a "real and clear possibility," forecasting that "the Fed is very likely to raise rates by 0.75 percentage points."

Notably, these media outlets presented their forecasts without disclosing sources, implying that the reports were made during the Fed’s blackout period and thus indirectly confirming the Fed’s stance. It appears that within the Fed, there is a growing consensus that only a more aggressive policy, exceeding market expectations, can curb the rising inflationary sentiment. Earlier, Fed Chair Jerome Powell distanced himself from the Giant Step possibility during a press conference following last month’s FOMC, but stated, "If there is no clear evidence that inflationary pressures are easing, we may adopt a more aggressive stance."

The rapid change in sentiment surrounding the Giant Step was also evident in the federal funds (FF) rate futures market that day. According to the Chicago Mercantile Exchange (CME) FedWatch, immediately after the New York stock market closed, futures priced in about a 28% chance of a 0.75 percentage point hike at this meeting, but within less than five hours, this probability surged to 95%.

◇Some Argue for a 1 Percentage Point Increase

Some voices argue that even the Giant Step is insufficient. Considering the current inflation trend, a 0.75 percentage point hike is not enough to serve as shock therapy. Michael Feroli, Chief U.S. Economist at JPMorgan Chase, who predicted the Giant Step that day, added that "there is a significant risk of a 1.0 percentage point increase," reflecting this view. Standard Chartered also suggested a 1.0 percentage point hike possibility with a 10% probability. Jeremy Siegel, a professor at the Wharton School of the University of Pennsylvania, stated in an interview with CNBC right after the CPI release last week, "I believe the Fed should raise rates by 1 percentage point."

However, this would inevitably act as a negative factor for global financial markets. On that day, the S&P 500 index in the New York stock market fell 3.88% from the previous session, entering a bear market by dropping more than 21% from the January 3 high (4796.56). This is the first time since March 2020, right after the pandemic (global outbreak), that it closed at such a low level. On the same day, the tech-heavy Nasdaq index plummeted 4.68%. The Morgan Stanley Capital International All Country World Index (MSCI ACWI), a global stock market indicator, also entered a bear market by falling 21% from the high recorded in November last year. Bloomberg reported that "since 1927, intermediate bear markets tend to last about 1.5 years," forecasting further declines ahead.

This content was produced with the assistance of AI translation services.