The markets will be looking to Wednesday’s U.S. CPI report for further information about whether the Fed will raise its federal funds target range by another +75 bp at its next meeting on September 20-21. However, the Fed will have some other key data to assess by the date of that meeting, such as the August payroll and CPI reports.
The markets are currently discounting about a 90% chance of a +75 bp rate hike at the next FOMC meeting on September 20-21. The November federal funds futures contract (FFX22) on Monday closed at an effective yield of 3.02%, which indicates strong expectations for the Fed to raise the funds rate target range by +75 bp to 3.00%/3.25% from the current range of 2.25%/2.50%. That would be the third consecutive +75 bp rate hike, following the +75 bp rate hikes in June and July.
After September’s +75 bp rate hike, the markets are then expecting a further +25 bp rate hike in late 2022 and another +25 bp rate hike by spring 2023, which would bring the federal funds rate to its maximum expected level of 3.62%.
After reaching the peak in spring 2023, the markets are then expecting the Fed to start cutting interest rates to address what is expected to be a weak U.S. economy in 2023 and 2024. The markets are expecting a -50 bp rate cut in the second half of 2023 and another -50 bp rate cut in 2024.
The FOMC, at its meeting in June, indicated that it believes that the longer-run level for the federal funds rate is 2.50%. Based on that neutral level, the markets are expecting the Fed to raise the funds rate to more than one percentage point above the neutral level to the mid-3% area by spring 2023 to address high inflation. However, the markets are then expecting the Fed to cut the funds rate back towards the neutral rate of 2.50% by 2025 as inflation and macroeconomic conditions normalize.
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