The Fed May Have To Raise Rates Much More Than Markets Expect

The Fed isn’t expected to raise rates this week, nor are the ECB or the BOJ. However, that does not mean the rate-hiking cycle is over. The market is pricing in a 25-basis-point Fed rate hike in December, which would raise the target range to 4%–4.25% from 3.75%–4%. However, Chair Warsh is unlikely to provide much guidance on the timing or extent of future rate hikes, leaving the market to draw its own conclusions from incoming economic data.

Overall, we are in a tightening cycle. The question is whether the market expects the Fed to raise its policy rate back to the restrictive levels last seen in 2023. At least for now, the answer appears to be no, suggesting that the market views this tightening cycle as more of a recalibration than a return to aggressively restrictive monetary policy. The same holds true for the ECB, which is expected to raise rates as many as three more times by September 2027.

How much further central banks raise rates will depend on inflation, and this week’s PCE report is unlikely to offer much relief. However, the report comes on Thursday morning, after Wednesday’s Fed meeting. Headline PCE is expected to rise 0.5% m/m, while core PCE is forecast to rise 0.3% m/m. Not exactly cool readings.

Oil prices offer little reason to believe inflation will cool anytime soon, and they could worsen. WTI remains in an uptrend and is approaching a key resistance level at $105. A breakout above that level could send oil prices sharply higher, potentially back above $110 and perhaps even $115.

Meanwhile, the oil volatility index (OVX) appears to be breaking out of its own consolidation pattern. Rising implied volatility alongside rising oil prices is not a good combination, suggesting not only higher oil prices to come, but also higher inflation and potentially higher interest rates.

If oil prices break out alongside rising implied volatility, the market will likely need to price in a more aggressive path of central bank rate hikes, pushing interest rate expectations higher.

-Mike

Michael Kramer publishes independent macro and options research read across 10+ platforms and by institutional desks.

For institutional partners: research syndication, licensing, and bylined or white-labeled commentary for platforms, brokers, and publishers.

Inquire →

Glossary by ChatGPT

Core PCE: The Personal Consumption Expenditures Price Index excluding food and energy, a key measure of underlying inflation used by the Federal Reserve.

European Central Bank (ECB): The central bank responsible for monetary policy and price stability in the euro area.

Federal Open Market Committee (FOMC): The Federal Reserve committee responsible for setting the target range for the federal funds rate and directing US monetary policy.

Forward Guidance: Communication from central banks about the anticipated direction of monetary policy intended to influence market expectations and financial conditions.

Implied Volatility: The market’s expectation of future price fluctuations derived from options prices.

Market-Implied Rate Path: The expected trajectory of central bank policy rates inferred from financial market pricing, including interest rate futures and derivatives.

Monetary Tightening: Central bank actions intended to restrict financial conditions, typically through higher policy interest rates or reduced liquidity.

OVX: The Cboe Crude Oil ETF Volatility Index, which measures the market’s expectation of 30-day volatility in the United States Oil Fund based on options prices.

PCE Price Index: The Personal Consumption Expenditures Price Index, an inflation measure tracking changes in prices paid by US consumers for goods and services.

Rate Recalibration: An adjustment in monetary policy settings intended to bring interest rates into better alignment with prevailing economic and inflation conditions.

Resistance Level: A price level at which selling pressure has historically limited further advances in an asset.

WTI Crude Oil: West Texas Intermediate, a major US crude oil benchmark used in global energy pricing.

Disclosure

This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.