The economist John Maynard Keynes once famously quipped, “When the facts change, I change my mind.” And so it goes ahead of the Federal Open Market Committee’s policy meeting this week.
Based on movements inside the rate markets, quickly changing inflation expectations and a rattled investor class, we now expect the Federal Reserve on Wednesday to raise its policy rate by 75 basis points to a range between 1.25% and 1.50%. This reflects a change from our previous call of a 50 basis-point hike that we published on Monday.
The Fed will continue to lift the policy rate until its stands in a range between 3.25% and 3.5%.
In addition, we anticipate that the Fed will raise its policy rate by 50 basis points at its July and September meetings and then continue to lift the policy rate by 25 basis points until its stands in a range between 3.25% and 3.5%. At that point, it will consider pausing the increases to ascertain changes in the underlying real economy, inflation expectations, unemployment and financial conditions.
The unrelenting increases in inflation have precipitated an upheaval in the financial markets and have caused a significant tightening in U.S. financial conditions.
By end of day Monday, our RSM US Financial Conditions Index had fallen to 1.3 standard deviations below zero, indicating excessive levels of risk being priced into financial assets. In previous decades, these levels of risk have been associated with major disruptions in the business cycle and outright recessions.
Not only is the Federal Reserve faced with the risk of inflation becoming embedded into consumer and business expectations, but it must also factor market behavior into its policy decisions.
The era of low interest rates has spawned greater demand for speculative investments, which by their nature can lead to large swings in returns—from outsized gains to outsized losses.
The question for policymakers becomes to what degree the financial sector will be directly or indirectly affected by those swings and how best to mollify that exposure. We now call on the central bank to hike rates in such a way to restore investor confidence and maintain well-anchored medium to long-run inflation expectations.