Fed Swaps Show 75 Basis-Point Hike Is Fully Priced In After CPI

(Bloomberg) -- The swaps market moved to fully price in another jumbo-sized rate hike by the Federal Reserve at its meeting next week after inflation data came in hotter than expected.

The September overnight index swap contract rose to 3.11%, more than 75 basis points above the current effective fed funds, while the implied rate for where the Fed cycle will top out early next year leaped to about 4.3%. At the same time, however, swaps linked to Fed meeting dates suggest that the benchmark will be back down to less than 3.8% by the end of December 2023.

Treasury yields jumped across the curve, with the two-year rate soaring as much as 18 basis points to about 3.75%, the highest since 2007. Yields on 30-year bonds rose about six basis points to 3.57%, a level last seen in 2014, and trading below that of five-year notes. Benchmark 10-year notes climbed as much as 10 basis points to 3.46%. Dollar rallied. 

The consumer price index increased 0.1% from July, after no change in the prior month, Labor Department data showed Tuesday. From a year earlier, prices climbed 8.3%, a slight deceleration, largely due to recent declines in gasoline prices.

So-called core CPI, which strips out the more volatile food and energy components, advanced 0.6% from July and 6.3% from a year ago. All measures came in above forecasts.

“There is no question the market is wrong footed here,” said Gregory Faranello, head of US rates trading and strategy at AmeriVet Securities. “The Fed goes 75bps next week and the question is are we going to 4.5% or higher? It keeps the heat on the Fed and the market. In the grand scheme of things rates are still low.”

To Mark Hamrick, senior economic analyst at Bankrate Inc., the next Fed hike “may well not yet be the last” and those rate increases combined with the reduction of the central bank’s massive balance sheet “will act to further dampen economic activity and likely weaken the job market.”

Traders are once again pricing in the prospect that the Fed will need to slash its benchmark rate by half a percentage point from its anticipated peak before the year 2023 is over. The pricing indicates concern that the increase in rates the Fed is likely to implement in order to tackle inflation could also drive the economy into recession and necessitate a re-easing of policy.

©2022 Bloomberg L.P.