Markets slightly drop as Fed policymakers embrace further rate increases

Its largest increase since 1994, the Federal Reserve last week increased its benchmark overnight interest rate by three-quarters of a percentage point to a range of 1.50 percent to 1.75 percent.

Interest-rate futures imply expectations for a policy rate of 3.5–4 percent by year’s end. Markets soon priced in even more aggressive rate hikes. Recession fears were highlighted by a number of economists and at least one former Fed policymaker.

Though a preliminary assessment released shortly before the Fed’s June policy-setting meeting had suggested otherwise, new data from the University of Michigan on Friday revealed longer-term inflation expectations had not risen over their most recent range.

One of the reasons policymakers supported the significant rate increase in June was the initial read of 3.3 percent, which Fed Chair Jerome Powell had cited as a possible early warning that months of 8 percent or higher consumer price inflation were beginning to erode the public’s confidence in the Fed’s ability to contain price pressures.

Mary Daly, president of the San Francisco Fed, stated on Friday that even if she had been aware of the updated 3.1 percent figure, she would still have supported a 75 basis point increase in June.

And she thinks that in order to deal with pricing pressures, which in her opinion probably have not peaked, another 75 basis point increase in interest rates will be required the following month, followed by more hikes.

Given that Daly is not a typically hawkish policymaker, her comments are particularly startling. According to her, rates should reach 3.1 percent by year’s end, which she considers to be a neutral level, though the Fed may need to take additional action if inflation increases.

In a speech earlier in the day, St. Louis Fed President James Bullard reiterated his demand for frontloading rate hikes to lower inflation to the Fed’s objective of 2 percent, saying the Fed must “act forthrightly and forcefully to get inflation to turn around and get it under control.”

Bullard has been one of the Fed’s most outspoken hawks since last summer.

Bullard and Daly both voiced confidence in the Fed’s ability to prevent a recession, pointing to the economy’s momentum and the strength of the job market, which were aided by extra household savings that, according to Daly, had not been depleted as quickly as she had anticipated.

Despite continuing to price in a 75-basis point increase in July, interest rate futures traders reduced their expectations for Fed rate increases and concluded the day with estimates for a year-end Fed policy rate of 3.4 percent, which is exactly what the Fed’s own projections imply.

The S&P 500 Index posted its largest one-day gain since May 2020 as US markets concluded the week higher.