When Do 100 bps Hikes Enter the Conversation

The past couple of decades have seen increasingly activist central banks intervene in markets. The Federal Reserve helped blow a housing bubble, then an everything bubble that it is now trying to unwind. Previously, they mostly followed the market. A couple of articles worth reading are De-mystifying RBA Setting of Interest Rates by Steve Keen and Here's How to Know When the Fed Might Raise Interest Rates by Vadim Pokhlebkin.

The 3-month Treasury bill rate is a proxy for the Fed funds rate. From the chart below, you can see the Fed funds rate used to fluctuate around the 3-month treasury rate. In the 2000 and 2008 recessions, and again in 2020, the market dropped interest rates faster than the Federal Reserve.

Something different is happening now. The market is raising interest rates faster than the Federal Reserve. If you notice the green line, the market takes rates up in between meetings and the Fed then catches-up by closing the gap to near zero. Notice the gaps widening? Remember Powell saying 75 bps was off the table? Then it wasn’t. The Federal Reserve is following the market and not vice versa. If the market believed the Federal Reserve and was following it, then the gap between the market rates and Fed funds rate would adhere to Fed policy and jawboning, and not the other way around.

The spread between the market and the Federal Reserve is still widening. The 3-month treasury yield is almost 125 basis points ahead of the Fed funds rate heading into this meeting 114 bps according to FRED). This is a wider gap than existed in June when they switched to 75 basis point rate hikes.

The current gap might not enough for a 100 bps rate hike because it would leave less than a quarter point gap. However, a 75 bps hike will leave the gap at around 39 bps. Notice that will be lower than the gap than at all previous rate hikes. The Fed should hike 100 bps if this chart factors into their decision making. The chart is saying the Fed is not only losing its battle, but that it is in a worse position today than it was at the start of its rate hiking.

With the market currently 50/50 on a 50 bps vs 75 bps hike in December, the Fed can push those odds with a hawkish statement, but they’ll still be behind again in December unless the market slows its pace.

In conclusion, the Federal Reserve is chasing the market higher and, key point, the market is accelerating its rate hikes. The Fed’s 75 bps pace falling behind the market’s pace. The speculators on Fed policy are undecided between 50 bps and 75 bps for December. If the bond market doesn’t slow down or worse, continues accelerating, 100 bps hikes might be on the table.