US rate markets price in aggressive 75-bps hike on Wednesday

INVESTORS have dramatically raised their bets that the US Federal Reserve will raise interest rates by 75 basis points (bps) rather than 50 bps on Wednesday, a swing in expectations that has fuelled a violent selloff across world markets.

Expectations for a 75-bps hike at the June meeting jumped to 89 per cent on Tuesday from only 3.9 per cent a week ago, according to CME’s Fedwatch Tool.

Consequently, expectations of a 50 bps rate hike on Wednesday have melted to 11 per cent from a surefire bet a week earlier.

Investors worry that a 75-bps rate increase, which would be the biggest since 1994, will negatively impact the valuation of equities, particularly technology stocks, and jeopardise the post-Covid-19 recovery.

Monday’s selloff confirmed a so-called bear market for the US S&P 500 equity index, which is down more than 20 per cent from its most recent closing high.

On Tuesday, investors continued to sell US stocks as investors braced for an aggressive Fed.

In the Treasuries market on Tuesday, US two-year yields, which are highly sensitive to rate expectations, spiked to 3.439 per cent, the highest since November 2007. Benchmark US 10-year yields touched 3.479 per cent, their strongest level since April 2011.

The yield curve between two-year and 10-year notes briefly inverted on Tuesday as far as 5.4 bps, which typically suggests an incoming recession. The curve was last steeper at 4.2 bps.

The Fed ends its two-day meeting on Wednesday amid data last Friday showing that US consumer prices had risen at their fastest pace since 1981.

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Data showed that in the 12 months through May, the US consumer price index (CPI) surged 8.6 per cent, the largest year-on-year increase in roughly 40 years. The so-called core CPI climbed 6.0 per cent in May on a year-on-year basis.

Some investment banks, including Goldman Sachs, said they now expected 75-bps increases in June and July, and then a 50-bps hike in September. TD Securities expects the same quantum of rate hikes in June and July.

The US Federal Reserve should raise its Fed Funds rate to 3 per cent on Wednesday, Jeffrey Gundlach, the chief executive officer of DoubleLine Capital said on Twitter late on Tuesday.

“The market has quickly adjusted rate hike expectations for the next few meetings, including 75 bps each for June and July,” said Mauricio Agudelo, head of fixed income investments at Homestead Funds.

“In our view, the market is already doing the tightening for the Fed, therefore the Fed must deliver.” REUTERS