Fed expected to intensify inflation fight with 75-basis point rate hike

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The Federal Reserve is expected to ratchet up its fight to tame scorching-hot inflation on Wednesday with the first 75-basis point rate hike in close to three decades, a move that threatens to slow U.S. economic growth and exacerbate financial pressure on Americans.  

With inflation unexpectedly accelerating to a fresh 40-year high in May, the Fed is under mounting pressure to move more aggressively to cool demand and slow surging consumer prices.

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Central bank policymakers raised the benchmark interest rate by a half-percentage point – double the typical size – in May, and laid out a roadmap for similarly sized increases at their meetings in June and July, assuming that data evolved as expected. But a string of alarming inflation reports in recent weeks could force the Fed to shift course.

A dismal Labor Department report last week showed the consumer price index rose 8.6% in May from a year ago, faster than expected. It marks the fastest pace of inflation since December 1981 and dashes economists' hopes that the consumer price spike was starting to fade. And a different survey released Monday showed that households are bracing for notably faster price increases – a worrisome sign because Fed officials believe such expectations can be self-fulfilling. 

"Based on movements inside rate markets, quickly changing inflation expectations and a rattled investor class, we now expect the Federal Reserve to hike its policy rate by 75-basis points at its June meeting," said Joe Brusuelas, RSM chief economist. "The unrelenting increases in inflation have precipitated an upheaval in the financial markets and caused a significant tightening in U.S. financial conditions."

The Fed has not approved a 75-basis point rate hike since 1994, underscoring just how bad the inflation crisis has become. 

Federal Reserve Chair Jerome Powell pauses during a news conference in Washington on Jan. 29, 2020. (AP Photo/Manuel Balce Ceneta, File / AP Newsroom)

Chairman Jerome Powell has so far avoided spooking the markets with surprise moves and previously rebuffed the possibility of a 75-basis point hike. But that was before the April and May inflation reports came in hotter-than-expected, reviving the possibility of a previously unthinkable 75-basis point increase. Powell also pledged that any steps the Fed takes would be guided by the latest economic data. 

"What we need to see is clear and convincing evidence that inflation pressures are abating and inflation is coming down," Powell said last month. "And if we don’t see that, then we’ll have to consider moving more aggressively."

Many economists believe the Fed is acting too late to quell inflation, with the Fed's benchmark rate sitting at a range of just 0.75% to 1.0%. Barclays, Goldman Sachs and Jefferies are now forecasting a 75-basis point hike this week, which would put the range at 1.5% to 1.75%. 

Wall Street is also bracing for a series of more aggressive rate hikes, with 90% of traders penciling in a 75-basis point increase on Wednesday, according to the CMEGroup's FedWatch tool, which tracks trading. The possibility of a super-sized rate hike rattled markets this week, extending a global selloff that sent the S&P 500 tumbling back into a bear market territory on fears the Fed could inadvertently trigger a recession.

Although policymakers are counting on finding that elusive sweet spot — known as a soft landing — history shows that the U.S. central bank often struggles to successfully thread the needle between tightening policy and preserving economic growth. Hiking interest rates tends to create higher personal and business loans, which slows the economy by forcing employers to cut back on spending.

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"The Federal Reserve's job gets more challenging by the day with inflation at a new 40-year high, coupled with a broader weakening of the economy," said Danielle DiMartino Booth, the CEO and chief strategist at Quill Intelligence and a former Dallas Fed advisor. "The Federal Reserve is tightening policy into a recession."