Federal Reserve to raise rates by 75 basis points, Wall Street firms expect

The latest consumer price gains and inflation expectations will likely prompt the Federal Reserve to raise interest rates so significantly for the first time in over two decades at its meeting this week.

The Fed's policy meeting ends on Wednesday. At his press conference following the meeting in May, Chairman Jerome Powell said that the central bank would likely raise rates in June and July depending on the data. It was a clear signal from the chairman.

Since the inflation numbers have been higher than expected in the past few days, investors have started to bet that the Fed will raise rates by 75 basis points at its meeting this week. A report in the Wall Street Journal reinforced the bets on a larger rate hike.

The signal of hiking interest rates affected US futures and Asian stocks. The three-day selloff in the S&P 500 had sent the index into bear market territory.

Meanwhile, the selloff in Asia continued on Tuesday as investors grew more convinced that the Fed would raise rates at its meeting this week. The region's stock markets fell over 1.5%, with China, Hong Kong, and Japan leading the decliners.

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Federal Reserve faces criticism due to high inflation

Some prominent Wall Street firms, such as Goldman Sachs and Morgan Stanley, shifted their call on the rate hike to 75 basis points from 50 basis points. Others, such as Bank of America, changed their positions to a larger increase.

Since Powell and his colleagues were criticized for their slow response to the global pandemic and for allowing inflation to rise faster in 40 years, they have repeatedly said that they would do whatever it takes to keep prices under control. While the Fed set a baseline for the rate hike in June and July, they also noted that the economy would evolve along the same lines.

On Friday, the consumer price index rose 8.6% in May, which was the fastest increase in 40 years. The data showed that inflation is still rising. It was a sign that the economy is still experiencing price pressures.

A couple of hours later, the University of Michigan released data that showed that consumer sentiment in the US dropped to a record low in early June. The survey respondents also noted that they expect inflation to rise to 3.3% over the next five years.

The drop in consumer sentiment concerns the Fed, as it suggests that inflation expectations are starting to become entrenched in the economy. If the expectations of consumers and businesses become unanchored, it could trigger a cycle of higher prices.

On Monday, the New York Fed released another survey that showed that inflation expectations rose in May. The one-year forward rate of inflation was at 6.6%, the highest level since the survey started in June 2013. However, the three-year projections remained steady at 3.9%.

How 75 basis-point increase benefits the Fed

A 75 basis-point increase would signal the Fed's intention to gradually raise interest rates. It would allow the central bank to maintain its stance of tight monetary policy while letting markets price in the possibility of slower growth.

A 75 basis-point increase could also boost the Fed's credibility. However, it could also cause market volatility as it increases the expectations of the Fed's next move. However, it might suggest that the Fed has not delivered its promise to improve the forecasting accuracy.