Citigroup economists now expect the Federal Reserve to approve a historic, 100-basis point interest rate hike when policymakers meet at the end of the month following the hotter-than-expected June inflation report.
"In June the committee showed it would react to each monthly inflation reading," Citigroup economists led by Andrew Hollenhorst wrote in a note to clients. "We now expect the Fed to deliver a 100 basis-point rate hike at the meeting later this month."
That would be the first rate hike of its size since the Fed started announcing moves in the overnight federal funds rate in 1994 and would put the benchmark range between 2.5% and 2.75%.
Investors lifted their expectations of a mega-sized rate hike following the scorching-hot Labor Department report released Wednesday, which showed the consumer price index rose 9.1% in June from a year ago, exceeding market expectations. It marks the fastest pace of inflation since December 1981. Wall Street is now penciling in a 28% chance of a mega-sized rate hike at the Fed's July 26-27 meeting, according to the CME Group's FedWatch tool.
"Everything is in play," Atlanta Fed President Raphael Bostic told reporters in St. Petersburg, Florida, on Wednesday following the latest inflation data. Asked whether that included a full percentage point interest rate hike, Bostic said: "It would mean everything."
Federal Reserve Chairman Jerome Powell largely rebuffed the possibility of a 100-basis point interest rate hike at the central bank's June meeting, during which officials pivoted at the last minute and voted to lift rates by 75 basis points – the first increase of its kind since 1994. Powell signaled that either a 50-basis point or 75-basis point hike was likely in July.
But that was before the June inflation report, which experts agree was resoundingly bad, underscoring just how strong inflationary pressures in the economy still are. Bond yields spiked higher and stocks tumbled after the worse-than-expected report fueled fears that the Fed will have to ratchet up its inflation battle.
The Fed is in a precarious situation as it walks the line between cooling consumer demand and bringing inflation closer to its 2% target without inadvertently dragging the economy into a recession. Hiking rates tends to create higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending.
Powell has acknowledged the risk of a recession but maintained that it's more important for the Fed to tame inflation, even if an economic downturn ensues.
"Is there a risk we would go too far? Certainly there’s a risk," Powell said last month. "The bigger mistake to make—let’s put it that way—would be to fail to restore price stability."