FX.co ★ Possible scenarios of further monetary tightening by Federal Reserve

The biggest US indices – the Dow Jones Industrial Average, Nasdaq Composite, and S&P 500 – closed slightly higher on Thursday. In the past few days, however, they were edging down. The three indices keep hovering around their yearly lows and extending the downtrend. Since there have been no changes in the fundamental background lately, we can hardly expect the trend to reverse upward. In addition, the latest inflation report shows that the Fed is unlikely to slow down the pace of monetary tightening. Inflation soared to 9.1% year-on-year, beating market expectations of 8.8%. As a reminder, the increase came when the interest rate in the United States was 1.75%. That is, inflation has shown no reaction to the regulator's actions so far. In this light, there are three possible scenarios for further monetary tightening, of which one seems highly unlikely. So, here are all three of them:

Scenario 1. The Fed raises the interest rate by 0.5%. We consider such a possibility just because Chairman Powell said in one of his latest speeches that there could be a 0.5% or 0.75% rate hike. However, there is a 0% likelihood of such a scenario. Inflation is still on the rise. So, tougher measures are needed to bring it under control.

Scenario 2. The Fed announces a 0.75% rate increase. We believe that the possibility of such an outcome is 60%. The inflation rate in the United States remains high and shows no reaction to the regulator's attempts to tame it, which means that the current pace of monetary tightening is not enough. Overall, however, a 0.75% rate hike would be the most reasonable solution.

Scenario 3. The interest rate is lifted by 1.00%. We considered such a possibility at the beginning of this week, before the release of the US inflation report. When data finally came in, many global financial institutions and banks also started talking about the likelihood of a 1.00% rate increase. Indeed, since the current pace of monetary tightening is not enough, it should be accelerated. This scenario has a 40% probability.

Since the latest inflation report was published in June and the latest FOMC meeting took place the same month, we believe that the interest rate will be raised by 0.75%. Inflation simply had not enough time to somehow react to the latest rate hike. Therefore, the Fed is unlikely to take a risk. In any case, pressure on the US equity market, the crypto market, and all risk assets (EUR, GBP) will mount.