[Comprehensive] "Big Step Not Enough" Fed Fails to Curb Inflation, Will It Ultimately Take a 'Giant Step'?

[Asia Economy New York=Special Correspondent Joselgina] Amid soaring inflation, the U.S. central bank, the Federal Reserve (Fed), is increasingly expected by Wall Street to take a ‘giant step’ by raising the benchmark interest rate by 0.75 percentage points at once. Fears of a recession have intensified due to the prospect of aggressive monetary tightening, causing global stock markets to plunge into panic selling. The S&P 500 index, representing the New York stock market, as well as the global stock market indicator Morgan Stanley Capital International All Country World Index (MSCI ACWI), have officially entered a bear market, having dropped more than 20% from their previous highs.

Major media outlets such as The Wall Street Journal (WSJ), Bloomberg, CNBC, and The New York Times (NYT) all simultaneously reported on the possibility of a giant step on the 13th (local time), leading with their own forecasts. The flood of such reports during the Fed’s blackout period, when Fed officials are prohibited from public comments, has led to speculation that there may have been some tacit communication with the authorities.

JPMorgan Chase and Goldman Sachs, the largest U.S. investment banks, also announced in investor memos on the same day that the Fed is expected to raise interest rates by 0.75 percentage points at the Federal Open Market Committee (FOMC) meeting held over two days starting the next day. Michael Feroli, JPMorgan Chase’s chief U.S. economist, said, “This decision reflects the soaring inflation expectations among Americans,” adding, “There is even a non-trivial risk of a 1.0 percentage point increase.” If the Fed takes a giant step, it will be the first time in 27 years and 7 months since former Chairman Alan Greenspan raised rates by 0.75 percentage points in November 1994.

According to the Chicago Mercantile Exchange (CME) FedWatch tool, the federal funds (FF) rate futures market currently reflects a 95.1% probability of a 0.75% rate hike at the June FOMC. This is a sharp increase compared to just 3.1% a week ago. On the same day, immediately after the New York stock market closed, the probability was around 28%, but it surged to the 95% range in less than five hours following the flood of giant step reports from major investment banks and foreign media.

◇Inflation Expectations More Frightening Than Inflation... Giant Step Gains Momentum

Until just a few days ago, the giant step was considered an unlikely option. The Fed had been signaling a big step (0.5 percentage point increase) at the June-July meetings, drawing a line against a giant step. However, the atmosphere sharply reversed a day before the FOMC began due to persistent inflation that refuses to be tamed. With inflation showing no signs of easing despite consecutive rate hikes, the Fed is now seen as resorting to a ‘shock therapy.’

The giant step card gained traction after the U.S. consumer price index (CPI) for May rose 8.6%, the highest since December 1981. Additionally, U.S. consumers’ inflation expectations for the next year hit an all-time high, amplifying voices that a big step (0.5 percentage point increase) is insufficient. According to the Federal Reserve Bank of New York, the expected inflation rate for the next year rose by 0.3 percentage points to 6.6% in the May consumer outlook survey. This confirms that inflation is expected to remain elevated for some time.

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 chorus. Local media outlets also uniformly reported on the giant step possibility. WSJ stated, “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 increase 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 a very high chance of a 0.75 percentage point hike by the Fed.

Notably, these media outlets presented their reports as forecasts without revealing sources, implying that the reports were made considering the Fed’s blackout period and indirectly confirming they reflect the Fed’s stance. It is believed that within the Fed, there is a growing consensus that only a tougher policy than market expectations can curb rising inflationary sentiment. Earlier, Fed Chair Jerome Powell distanced himself from the giant step possibility at 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.”

◇Some Argue for a 1% Point Increase... Stock Markets Plunge Amid Tightening Concerns

Some voices argue that even a giant step is insufficient. Considering the current inflation trend, a 0.75 percentage point increase is not enough as shock therapy. Diane Swonk, chief economist at investment firm Grant Thornton, pointed out, “The Fed’s response has been delayed compared to the speed of inflation increase, and the Fed is aware of this.”

Michael Feroli, JPMorgan Chase’s chief economist who predicted the giant step on the day, added, “There is a non-trivial risk of a 1.0 percentage point increase,” in line with this view. Standard Chartered also suggested a 10% probability of a 1.0 percentage point hike. Jeremy Siegel, professor at the Wharton School of the University of Pennsylvania, stated in a CNBC interview after last week’s CPI release, “I think the Fed should raise rates by 1 percentage point.”

However, there is also analysis that a sudden shift to aggressive tightening could confuse market expectations and undermine trust. Bloomberg reported, “The Fed’s probability of a 0.75 percentage point rate hike soaring to the 90% range may be an admission of how poor its own forecasts have been.”

Heightened tightening concerns led to the stock market experiencing a ‘Black Monday.’

On that day, the S&P 500 index in New York fell 3.88% from the previous close, dropping more than 21% from the previous high of 4796.56 on January 3. This marks the first time since March 2020, right after the pandemic, that the S&P 500 has entered a bear market based on closing prices. The Nasdaq index, focused on tech stocks, plunged 4.68% on the same day. The MSCI ACWI, a global investment benchmark for institutional investors, also entered a bear market, falling 21% from its high recorded in November last year.

Experts warn of further declines in the New York stock market. Typically, from June, the market enters the so-called June Swoon as Wall Street goes on summer vacation, leading to sluggishness. UBS conveyed the mood, saying, “Investors fear that the Fed’s rate hikes will inevitably accelerate due to the prolonged high inflation.” Bloomberg projected further declines, noting, “Since 1927, intermediate bear markets tend to last about 1.5 years.”

On the same day, bond yields surged in the New York bond market. The U.S. 10-year Treasury yield briefly soared to 3.44% during the session before easing somewhat. The 2-year yield also jumped, causing a yield curve inversion where the 2-year yield exceeded the 10-year yield for the first time since early April. Typically, yield curve inversion is interpreted as a signal of recession.

James Gorman, CEO of Morgan Stanley, warned that day, “I thought the recession risk was about 30%, but now it’s close to 50%.”

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