[Super Tightening Era] US Interest Rate Expected to Jump by 0.5%P... Big Step for the First Time in 20 Years

[Asia Economy New York=Special Correspondent Joselgina] Big Step or Baby Step?

The U.S. Federal Reserve (Fed), transformed into an inflation fighter, is considering the 'Big Step' card of raising the benchmark interest rate by '0.5 percentage points' at once. Despite the Fed's signal to mobilize all means, inflation in the U.S. has soared to the highest level in 40 years and shows little sign of easing. There are even voices suggesting that this rate hike could be a 'Big Bang' level event.

◇Will the Fed take the '0.5 percentage point' Big Step?

According to the CME Group's FedWatch on the 10th (local time), the probability that the Fed will raise rates by 0.5 percentage points in March surged from 24.0% the previous day to 93.8% on the day. This estimate is based on federal funds rate (FFR) futures price data and reflects the likelihood of a Fed policy change. Considering it was only 7.3% a month ago, the market has sharply turned 'hawkish.' Citigroup economists also predicted that after a 0.5 percentage point hike in March, the Fed would raise rates four more times by 0.25 percentage points in May, June, September, and December.

The so-called Big Step of a 0.5 percentage point increase was last taken in May 2000 during the dot-com bubble. Since then, the Fed has maintained a 0.25 percentage point rate hike per meeting (Baby Step) almost as a rule.

The reason why speculation about the Fed choosing a Big Step for the first time in over 20 years is spreading is due to inflation in the U.S. The January Consumer Price Index (CPI) released that morning showed a 7.5% increase compared to the same month last year, marking the largest rise since February 1982. This exceeded both market expectations and the previous month's 7.0%. The core CPI, which excludes volatile energy and food prices, also surged 6.0% year-over-year.

James Bullard, president of the Federal Reserve Bank of St. Louis and a prominent hawk within the Fed, appeared on Bloomberg right after the CPI release and said, "In the past, after such a report, the Fed would have met and immediately raised rates," adding, "I support a 1.0 percentage point increase in the benchmark rate by July 1." There are only three remaining Federal Open Market Committee (FOMC) meetings before July 1, making at least one 0.5 percentage point hike essential.

Karim Basta, chief economist at Triple-I Capital Management, recently mentioned the market sentiment, inflation, and employment indicators, stating, "All of this supports a 0.5 percentage point hike in March." If the February CPI, released before the March FOMC, again hits the 7% range, the possibility of a Big Step will inevitably increase.

◇"Tame inflation" QT likely to accelerate

Besides raising interest rates, the Fed, struggling with inflation, can also use quantitative tightening (QT), which involves shrinking its balance sheet. President Bullard mentioned starting QT by not reinvesting maturing bonds and possibly actively selling Fed-held assets.

The Fed's assets, which were $4.1 trillion in January 2020, surged to about $8.8 trillion due to bond purchases to supply liquidity during the COVID-19 pandemic. Wall Street experts believe that reducing the Fed's assets by $500 billion has a similar effect to raising rates by 0.25 percentage points.

Loretta Mester, president of the Federal Reserve Bank of Cleveland, said at an online event the day before, "We need to move faster than the last time we did QT," mentioning options such as selling mortgage-backed securities (MBS) before maturity. Rick Rieder, Global Chief Investment Officer (CIO) of Fixed Income at BlackRock, the world's largest asset manager, pointed out that "the Fed is still increasing financial market liquidity through quantitative easing and plans to continue until mid-March," emphasizing that the Fed should immediately stop bond purchases to curb inflation.

Some speculate that the Fed might also use the strong dollar card. Since it takes time for the effects of rate hikes to become visible, the Fed may respond to inflationary pressures by lowering import prices, among other methods.

◇Latin American countries continue rate hikes

Meanwhile, Latin American countries outside the U.S. are continuing their rate hike marches to curb steep inflation. On the same day, the Bank of Mexico raised its benchmark rate from 5.5% to 6.0%, marking the sixth consecutive increase since June last year. The last two hikes were by 0.5 percentage points each. The Central Bank of Peru also raised its benchmark rate to 3.5%, marking its seventh consecutive increase.