Why investors fear a full-percentage-point Fed rate hike will ‘turbulent’ Wall Street?

The Fed has raised interest rates by two 75 basis points so far this year. A previous version of this story said it had delivered three.

With both US stocks and bonds under pressure on Tuesday, some on Wall Street argue that investors are underestimating the possibility that the Fed will surprise 100-basis at the end of its two-day policy meeting on Wednesday. -Point may give interest rate hike. ,

While fed-funds futures traders expected a rise of 75 basis points, or 0.75 percent, on Wednesday, their concern is that last week’s August consumer-price index print, with the labor market still strong, has reassured the Fed chair. can. Jerome Powell and other hardliners on the Fed’s policy-making committee said they should do more than just stay on course as they struggle to curb inflation.

Instead, Fed policymakers may feel they should act more forcefully.

Should it pass, it would be the most aggressive example of Fed tightening since the days of Paul Volcker, who served as Fed chairman from 1979 to 1987, on the heels of two 75-basis-point “jumbo” rate hikes. Coming on shoes, and a 50 basis point increase in May.

See: Biggest Fed rate hike in 40 years? It could come this week.

Many are concerned that bringing the hammer down so strongly would risk spreading the pandemic across markets by essentially taking the prospect of a “soft landing” off the table for the US economy. Others are more concerned that failing to heel the markets now could lead to worse consequences down the road.

How will the markets react?

Sam Stovall, chief investment strategist at CFRA, said in a note to clients that the 100-basis-point increase would represent an “exaggeration” on the Fed’s part.

“We think a 100 bps increase will upset Wall Street, as it would mean the FOMC is overreacting to data rather than sticking to its game plan, and will increase the likelihood that the FOMC will eventually overtake and will reduce the chances of achieving a soft landing,” Stovall wrote in a note to customers.

With short-term yields already close to the pressure point of around 4%, the always carefully choreographed Fed probably wouldn’t want to risk upsetting the markets like this.

See: A punitive sell-off in short-term debt is pushing a rate near ‘magic’ levels that ‘scared’ the markets

“The Fed is telegraphing 75 basis points. If they go to 100 basis points, I think it will be shocking for the market,” David Rubenstein, billionaire founder of private-equity giant Carlyle Group, told Fox Business on Monday. Said during an interview with.

But assuming the Fed opts for an astonishing full-percentage hike, some can imagine a scenario where markets actually rally in the face of a more rigid Fed.

“Not predicting this by any means, but I can see a scenario where we get 100 and the market actually (after the initial flush) rally based on the idea that the Fed is slowly removing it. instead of shutting down the Band-Aid,” said Matt Tuttle, CEO of Tuttle Capital Management, in an email exchange with MarketWatch.

Whats up?

Certainly, a 100-basis-point increase is still widely viewed as an outcome with little chance. Fed-funds futures markets are currently pricing in around 80% odds of a 75-basis-point hike on Wednesday, with the full percentage-point move sluggish at 20%. CME’s Fedwatch Tool.

So far, Japanese investment bank Nomura has been one of the few major sell-off institutions to call for a 100-basis-point rise on Wednesday.

But the logic of why the Fed may have decided to deviate from its policy of carefully choreographed moves has clearly resonated with investors, evidenced by the fact that so many Wall Street strategists provided clients and the media The research has chosen to address the possibility. ,

In a research note published early Tuesday, Nomura cross-asset strategist Charlie McElligott explained that he believes markets are “significantly reducing” the likelihood of a 100-basis-point increase.

His reasoning: After the latest batch of economic data, Powell can’t afford a positive market reaction on Wednesday, as it will ease “counterproductive” financial conditions, which occur when stock prices rise and bond yields fall. Is.

If Powell’s objective is to keep inflation from freezing, he needs to demonstrate that he is “fully dial-in on his ‘inflation’ mandate alone,” economic data in particular suggests, a preliminary The wage-price spiral is already taking hold, McLygott wrote.

“100 bps is a requirement to hit the demand-side of inflation as hard as possible,” McElligot said in a note to clients on Tuesday.

See: Can the Fed control inflation without further crushing the stock market? What investors need to know

What is the option?

If the Fed offers a 100 basis-point increase, such an aggressive move would force markets to assume the possibility that the fed-funds rate could rise above 5% next year, which could lead to markets and Will probably be a curse to the economy. This is the reason why economist Michael Feroli of JPMorgan Chase & Co. is shying away from making 100 basis points as his base.

See: A rising US dollar is already sending a ‘danger signal’s,’ economists warn

“We think the probability of a 100 basis-point move – though certainly not zero – is less than a third … Published in note. In the middle of last week.

Instead, as Feroli informed JPM clients last week, the US megabank expects the Fed to make a slightly bigger hike in November, as well as an additional 25 basis-point hike early next year. An additional 50 basis points of expected tightening will help bring the upper band of the Fed’s interest rate target to 4.25% by next spring, which is still much higher than many expected in July.

Anything beyond that will entirely depend on the state of the economic data.

“If the labor market does not cool down physically by January-February, we will continue to tighten the committee in 25bp moves until that happens,” Feroli said.

US stocks were trading lower on Tuesday with the S&P 500 SPX.
-1.13%,
Dow Jones Industrial Average DJIA,
-1.01%
and Nasdaq Composite Comp,
-0.95%
Firmly in red. Meanwhile, the 2-year Treasury yield TMUBMUSD02Y,
3.975%
was trading at less than 4%, which is seen as a level that could cause more headaches for the equity market.

See: Why Rising Treasury Yields Are a Pressure on the Stock Market

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