Investors bet on Federal Reserve to raise interest rates on Wednesday despite weaker inflation data

 
Jasper Jolly
Follow Jasper
ITALY-DIPLOMACY-G7-FINANCE
The Federal Reserve's Janet Yellen will discuss the monetary policy outlook on Wednesday (Source: Getty)

The Federal Reserve is expected to hike its key federal funds rate for the second time this year on Wednesday despite a softer inflation outlook.

Investor expectations of a rate hike have reached fever pitch, with markets pricing in a 95.8 per cent chance of the Fed making a move, according to calculations by CME Group.

The central bank left the target for the federal funds rate, the interest rate offered to other banks, between 0.75 and one per cent at the last meeting in May, with a 25 basis points move to an upper bound of 1.25 per cent now on the cards.

Read more: Fed hike in June a certainty? US GDP slowdown wasn't actually so bad

Another rise in interest rates on Wednesday at 7pm UK time would represent only the fourth upwards move in the federal funds rate since before the financial crisis, as the world’s most important central bank takes a cautious approach to the "normalisation" of monetary policy.

Investors will carefully scrutinise the central bank’s latest projections, as well as the expectations from members of the rate-setting federal open market committee (FOMC) for further interest rate increases, shown in the “dot plot” published alongside the monetary policy statement.

Some economists believe investors betting on further tightening could be disappointed by the central bank, with recent inflation and growth data disappointing. Core personal consumption expenditures inflation, the Fed’s preferred measure, fell back to 1.5 per cent in April, well below its two per cent target.

Read more: The Fed leaves rates unchanged and says slow US growth will be temporary

Anna Stupnytska, global economist at Fidelity International, said: “I believe the Fed’s hike in June is likely to be the last rate rise for 2017. Easy financial conditions have emboldened the Fed this year, but the economy has clearly not played ball.”

Another aspect of caution on policy normalisation is the central bank’s slow moves to start to reduce the size of its massive balance sheet, with FOMC chair Janet Yellen set to face multiple questions on when and how it will unwind the massive stimulus still in place.

The Federal Reserve could choose this meeting to announce it will start letting securities “roll off” its books by not reinvesting the proceeds of maturing bonds, according to economists at JP Morgan.

The Fed currently holds almost $4.5 trillion of assets, mostly in US Treasury bonds and mortgage-backed securities. The assets were bought during the quantitative easing programme, which was designed to pump money into the economy after the global financial crisis.

Related articles