Fed likely to boost interest rates by three-quarters of a point this week

Key Points
  • Fed policymakers are entertaining the idea of a 75-basis-point rate increase this week, according to CNBC's Steve Liesman.
  • Bond yields pointed to the possibility of a more aggressive Fed as the yield on the 10-year Treasury shot up to 3.37%, while the 2-year yield, which mostly closely tracks Fed intentions, accelerated to 3.34%.
The Fed is entirely focused on crushing inflation, says JPMorgan's Michael Feroli
The Fed is entirely focused on crushing inflation, says JPMorgan's Michael Feroli

Markets are beginning to anticipate an even faster pace of interest rate hikes, and Federal Reserve officials apparently are contemplating the possibility as well.

Central bank policymakers are entertaining the idea of a 75 basis point increase to the Fed's benchmark funds rate that banks charge each other for overnight financing, according to CNBC's Steve Liesman.

Changes in the economic outlook, including the likelihood that inflation hasn't peaked and is running well ahead of the Fed's 2% goal, could influence a bigger rate move during the two-day meeting that concludes Wednesday.

A 75 basis point move is "a real distinct possibility," Liesman said.

An earlier Wall Street Journal story Monday afternoon first reported the change in central bank stance. The fed funds rate feeds through to many consumer products that are based on adjustable rates, such as mortgages and credit cards.

Goldman Sachs said it is altering its own expectation of a 50 basis point move to 75, citing the Journal's reporting and noting that the newspaper had a day previous reported that the bigger move was "unlikely."

The Wall Street firm's economists now foresee consecutive 75 basis point rate hikes in June and July, followed by a 50 basis point move in September and 25 basis point moves in November and December, taking the fed funds rate to a range of 3.25%-3.5% by the end of the year.

75 bps increase likely this week, per CNBC's Steve Liesman
75 bps increase likely this week, per CNBC's Steve Liesman

"The most likely triggers for a shift to a more aggressive pace of tightening are the upside surprise in the May CPI report and the further rise last Friday in the Michigan consumer survey's measures of long-term inflation expectations that has likely been driven in large part by further increases in gas prices," Goldman chief economist Jan Hatzius and others said in a note.

Krishna Guha, head of global policy and central bank strategy at Evercore ISI, noted the unusual nature of the media speculation so close to a meeting, when policymakers are prohibited from making public statements.

However, Guha noted that "until and unless we see some kind of unofficial clarification, we are forced to take the reports at what we think is face value: it looks like we were wrong and 75 is after all likely this week. We repeat that we think this is not optimal policy and would separately be bad for markets."

Market pricing reflected the changed expectations.

The CME Group's Fed Watch tool, which had been strongly pointing to a 50 basis point hike this week, was showing a 96% probability of a 75 basis point move as of Monday evening.

In recent days, traders in the interest rate futures market have been cranking up their bets that the Fed will go beyond its traditional 25-basis-point hiking pattern.

Recent jumps in bond yields have pointed to the possibility of a more aggressive Fed at the conclusion of the two-day Federal Open Market Committee meeting Wednesday.

The 10-year Treasury yield shot up to 3.37% Monday, a surge of 21 basis points, while the 2-year yield, which mostly closely tracks Fed intentions, accelerated to 3.34%, a jump of nearly 30 basis points. A basis point is one one-hundredth of a percentage point.

The Fed uses interest rate increases as a way to tamp down demand, which has generated inflation levels running at more than 40-year highs. Markets expect the central bank to continue jacking up rates through at least the end of the year as it tries to pull inflation down nearer its 2% target.

The Journal report did not cite any specific sources for its reporting but said that officials could reconsider their stance on rates in light of several recent reports showing that inflation is not only high historically but is continuing to push upward. The Fed is in its quiet period ahead of the two-day Open Market Committee meeting that opens Tuesday, so officials can't comment on policy.

Friday's consumer price index report showed headline inflation in May running at an 8.6% pace. That same day, the University of Michigan's widely followed consumer sentiment gauge fell to an all-time low, and the report also indicated a ramping up of inflation expectations.

A separate survey from the New York Fed released Monday indicated that one-year inflation expectations are at 6.6%, tied for a record in a data series that goes back to 2012.

The roots of inflation are multi-pronged: Clogged supply chains are pushing up prices, while energy prices are rising due to decreased production, a situation aggravated by the Russian attack on Ukraine. A supply-demand mismatch in the labor market also is fueling much higher wages, which in turn are leading to price increases.