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Traders start looking at even bigger Fed rate hikes after hot CPI

(Bloomberg) – Rates traders are now betting the Federal Reserve will raise its benchmark rate by at least three-quarters of a percentage point next week, with some talking that increase could be possible. need to be greater than the level after the consumer price inflation data to come hotter than expected.

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Investors are also increasing expectations about the extent to which they think the central bank can finally push policy rates in early 2023 – to around 4.3% – although it appears the relationship Concern is growing about whether that could cripple economic activity in a way that forces them to ease policy again before the end of 2023. Swaps linked to the Fed’s meeting date point to the point. benchmark will fall below 3.8% by the end of that year.

Meanwhile, the September 2022 overnight index swaps at one stage climbed as high as 3.13% on Tuesday, about 80 basis points more than the current effective lending rate. at, indicating a 75 basis point minimum tightening is seen. as a key for next week. It also implies a number of opportunities that officials may consider to raise in full percentage points. However, with Fed officials currently in a pre-meeting shutdown, there is little chance for the central bank to officially lay the groundwork for such a change, so all eyes will be on it. focus on market psychology and the media.

Treasury yields spiked above the curve, with two-year yields surging from 21 basis points to about 3.78%, their highest since October 2007. Yields on 30-term bonds rose about approx. 6 basis points to 3.57%, last seen. in 2014, and is trading below the 5-year yield. Yields on the benchmark 10-year bond rose as much as 10 basis points to 3.46%, while the dollar rose against its major currencies and US stocks fell.

The US consumer price index rose 0.1% from July, after being flat in the previous month, Labor Department data showed on Tuesday. Compared to a year earlier, prices were up 8.3%, down slightly, largely due to the recent drop in gasoline prices.

The so-called Core CPI, which excludes more volatile food and energy ingredients, rose 0.6% from July and 6.3% from a year ago. All measures are included in the above forecast.

“There is no doubt that the market is misbehaving here,” said Gregory Faranello, head of US FX strategy and trading at AmeriVet Securities. “The Fed is going to raise 75 percentage points next week, and the question is are we going to increase it to 4.5% or higher? It keeps the Fed and the market warm. In the master plan of things, rates are still low. “

Real 5-year and 10-year yields rose to 1% for the first time in more than 3 years, indicating continued tightening of financial conditions.

For Mark Hamrick, senior economic analyst at Bankrate Inc., the rate hikes combined with a reduction in the central bank’s massive balance sheet “will further impact economic activity and potentially weakening the job market.

Traders are once again pricing in the prospect that the Fed will need to cut its benchmark rate by half a percentage point from its predicted peak before 2023. The valuations indicate concern that the rate hikes the Fed may take to tackle inflation could also tip the economy into recession and require policy easing.

For now, though, policy moves appear to be firmly in place and immediate debate is on the scale of this month’s move.

“Don’t be surprised if the Fed is forced to take the Fed’s hand” and they end up tightening 100 basis points, said Nisha Patel, director and fixed-income portfolio manager at Parametric. “The idea that inflation has peaked has been dispelled, and now the possibility of a soft landing for the economy has only diminished. Long-term bond yield expectations are likely to fall ahead of the September meeting as recession risks mount. “

(Updated throughout.)

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