Will it be 75 bp or 100 bp Rate Hike by Fed ?

With the hot CPI report followed by hotter PPI report, hottest inflation in June of 9.1% for consumers and 11% for companies on the wholesale basis, a bigger rate hike by FED is now inevitable. Markets shifted expectations of the upcoming July rate hike from 75bp to 100bp. Earlier this week, market got surprised with a sudden 100 bp rate hike by the Bank of Canada, highlighting seriousness of the inflation threat and the need for decisive response.

 If we research and go through the CPI report for all Urban consumers, we will see that different nature of inflation for gasoline and utility gas, rose significantly more than others. In other categories, monthly price growth in most cases did not exceed 1%.The surprising upside of the inflation report should have been predicted as gasoline price jumped in June was public way earlier then the inflation report. High volatility good’s price and the high divergence in component price increases sponsored to the so called “SHOCKING” inflation figure for June.

 After the latest US inflation data, the July FOMC pricing has been shifted in favor of a full percentage (100 bp or 1%) as they hinted nothing is out of the table. The 9.1% inflation in June after the CPI has made it the hottest US inflation reading in 40-years. The monthly data shows headline CPI was seen coming in at 1.3% in June, up from 1% prior and well above the 1.1% the market was looking for. Additionally, core CPI was seen at 0.7% on the month, up from 0.6% prior and, again, well above the 0.5% the market was looking for. All these have put pressure on Fed to further rate hike even for a larger 1% hike, way over previous expectation of 75% hike, even though Fed has already increased 75% last time. Moreover BOC (Bank of Canada) has already increased its rate by 100bp or 1% earlier this week rolling it in favor for the same for USD.

A decline in inflation in following months could be quite rapid. Gasoline price inflation may slow down in July may result to cool down things. If Fed tighten it too sharply, it might harm the economy more rather then doing good to it. Given that, a 100 bp rate hike may be unreasonable.

It is also important to keep in mind that inflation generated by fuel prices growth is not the kind of inflation that can be effectively regulated by raising interest rate (via demand destruction), moreover, the pass-through effect of gasoline inflation into other categories, judging by the numbers, is not so strong.

European currencies are set to remain in the shadow of a strong dollar for a while as the factor of interest rate differential, until the Fed's policy stance is clarified on July 27, should keep these currencies under pressure. EURUSD consolidation near the 1.00 level with very weak attempts to rebound indicates a growing risk of a bearish breakout with a target of 0.98-0.99.

The upcoming retail sales data will give more detail outlook for into the US economy and may give traders a direction of where thing might go on upcoming FOMC meeting. If retail sales are seeing rising on the month, as forecast, this should keep USD higher into the FOMC meeting.

Now let’s see, will Fed go for 75 bp or 100 bp rate hike!