'Ugly' inflation report could put Fed rate hike of 75-basis points on the table

The dismal May inflation report has some Wall Street economists betting that the Federal Reserve will raise interest rates by 75-basis points in June or July as policymakers try to tame runaway consumer prices.

A majority of traders are already pricing in an 80% chance of a half-point rate increase during the Fed's June meeting, according to the CME Group, which tracks trading. Another 20% of traders think the Fed will move even more aggressively with a 75-basis point increase, the first since 1994. Odds for a super-sized rate hike are even higher in July, with more than 50% of traders penciling in a 75-basis point hike. 

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The new projections come on the heels of a scorching hot Labor Department report that showed the consumer price index, a broad measure of the price for everyday goods, including gasoline, groceries and rents, rose 8.6% in May from a year ago, faster than expected. Prices jumped 1% in the one-month period from April. It marks the fastest pace of Inflation since December 1981. 

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The latest inflation data also prompted Barclays economists to update their forecast, projecting a 75-basis point hike at the Fed's policy-setting meeting that is slated to take place next week.

"The U.S. central bank now has good reason to surprise markets by hiking more aggressively than expected in June," the strategists, led by Jonathan Millar, wrote in a note Friday. "We realize it is a close call and that it could play out in either June or July. But we are changing our forecast to call for a 75-basis point hike on June 15." 

Federal Reserve Chairman Jerome Powell rebuffed the possibility of a 75-basis point interest rate hike at the beginning of May following a policymakers' meeting at which they voted to lift rates by a half-point. Officials have signaled that half-point rate hikes are on the table in June and July, although it's unclear how Friday's report could affect that.

"A 75-basis point increase is not something that the committee is actively considering," Powell told reporters at the post-meeting press conference. 

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But that was before the April and May inflation reports, which both came in hotter than expected, underscoring just how strong inflationary pressures in the economy still are. Bond yields spiked higher and stocks tumbled after the worse-than-expected report fueled fears that the Fed will have to ratchet up its inflation battle.

"What an ugly CPI print. Not only was it higher than expected on almost all fronts, pressures were clearly evident in the stickier parts of the market," said Seema Shah, chief strategist at Principal Global Investors. "The Fed's price stability resolve is going to be really tested now. Policy rate hikes will need to be relentlessly aggressive until inflation finally starts to fade, even if the economy is struggling."