June FOMC Meeting Results: Fed Hikes Rates 75 Basis Points

QUICK LOOK:

• Federal Reserve announces a raise in interest rates to a new range of 1.50% to 1.75%, up 75 basis points (in line with market expectations).
• Federal Reserve anticipates ongoing increases to the Federal Reserve funds rate.
• Fed hikes 2022 inflation outlook to 3.4%, up from 1.9%.
• Largest rate hike since 1994.
• Fed cuts 2022 GDP growth forecast by -1.1%, from 2.8% to 1.7%.
• Core inflation outlook will decline to its target of 2.3% by 2024.
• One descent, Esther George, wanted a 50 basis point increase rather than 75.
• Fed anticipates additional increases to come.

Leadup to the FOMC

Over the past week, the market has been dropping like a rock, with the S&P down more than 7% since Wednesday. Conversely, the 2-Year Treasury Yield is up more than 20% over the same period.

Much of this move can be blamed on Friday’s record-breaking CPI Report, which indicated that the US economy had reached a 40-year inflationary high. That painful report puts a lot of pressure on the Fed to use all of the tools at their disposal to fight inflation.

Those tools include things like balance sheet reductions, increased size and pacing of rate hikes (including the potential use of inter-meeting rate hikes), and more. Even the words that Jerome Powell uses in his post-FOMC speech must be carefully chosen to prevent adverse reactions.

Market expectations ahead of the FOMC

Alongside that CPI data came a shift in market perception about the expectation of rate hikes. While the market was pricing in 50 basis points in June and July, that has now increased to an expectation of 75 basis points per meeting. Here’s a full look at the market’s expectations as of June 2022:

June: 75bp
July: 75bp
September: 50bp
November: 50bp
December: 25bp

Unusual Option Activity: How the Smart Money positioned themselves with options

Option order flow on Friday became highly bearish, with a high put/call ratio, and a multitude of high-cost put option trades being placed on SPY, QQQ, IWM, and ARKK. Many of those bearish trades have become highly profitable, with the market dropping significantly since then.

On the eve of the event, the action has gotten mixed. Big trades were placed on both sides: a sign of how institutional traders are forced to be nimble during highly volatile events like this.

Fed Chairman Powell Speaks

Following the FOMC rate decision, Fed Chairman Jerome Powell said:

• “The next meeting in July will likely see a rate increase of between 50 to 75 basis points.”
• ” I do not expect 75 bps to be common” but that it was “necessary due to an upside surprise in inflation.”
• “We are in the process of significantly reducing our balance sheet.”
• Data shows inflation expectations are still in a place where short-term inflation remains elevated, but he expects inflation to “come down sharply in the medium-term”.
• “If we don’t see clear progress on inflation, that could cause us to react. We’ll be careful about declaring victory.”
• “Interest rates must move into restrictive territory to bring inflation down.”
• “We can’t control supply-side issues.”
• “If the unemployment rate went up to 4.1% that’s still a historically low level. […] A 4.1% unemployment rate with inflation on its way to 2%, I think that would be a successful outcome. We’re not looking to have a higher unemployment rate, but I would certainly look at that as a successful outcome.”
• “It does appear the US economy is strong and well-positioned to deal with higher interest rates.”
• “There’s no sign of a broader slow down in the economy.”
• “We think the public generally sees us as very likely to get inflation down to 2% — and that’s critical, it’s absolutely key to this whole thing. That we sustain that confidence.”
• “If things go in a direction we didn’t expect, we’ll adapt. This is an extraordinarily uncertain environment. We’ll be determined and resolved, but flexible.”
• “Clearly, people don’t like inflation — a lot.”