SINGAPORE/NEW YORK – Rising expectations that this week’s Federal Reserve will raise interest rates more than originally forecasted on Monday upset investors, causing steep falls in U.S. bonds and stocks as well as intensifying concerns about the economic outlook.

On Wednesday, the Federal Reserve will meet following last week’s data showing that consumer prices in America rose at an unprecedented rate since 1981.

CME’s FedWatch tool based on short-term credit options prices shows that there is a 30% chance for a 75 basis-point rate increase at the next meeting. This compares to a 3.1% chance one week ago. The largest increase in rates since 1994 would have been a 75-basis point hike.

John Velis, strategist at BNY Mellon (NYSE.) stated Monday that the May inflation data had been so alarming that we believe the Fed will respond even more aggressively to moving rates “expeditiously”. He predicted that the Fed would increase rates by 75 basis points, up from 50 basis point predictions.

Barclays Jefferies and (LON) also predict a 75-basis point hike.

Barclays analysts wrote in a Sunday report that “U.S. CPI surprised the upside” and maintained broad price pressures. “We believe that the Fed may want to surprise markets and reaffirm its inflation-fighting abilities.”

On Monday the market appeared to confirm a bearish trend. However, a large portion of the Treasury yield curve was inverted due to fears that Fed hikes could tip the economy into recession. The benchmark 10-year Treasury yields reached their highest level since 2011. [.N]

Jim Paulsen is chief investment strategist for the Leuthold Group. “The markets do not wait until Wednesday’s Fed meeting. Instead, they will frontrun them.”

Wall Street large-scale investors said they are not expecting a move of 75 basis points, but that the possibility for a substantial rate rise in the coming months has increased.

Standard Chartered stated that even a 100 basis point increase could not be avoided.

‘INCESSION’

The market reacted by selling short-dated Treasuries and futures linked to the Fed rate. Since late 2007, yields on two-year Treasury notes are at their highest point. [US/]

The U.S. Terminal Rate – the Fed funds rate that may reach its peak in this cycle – continues to be a hot topic. Rates were expected to rise almost one percent in the middle of 2023 as rates rose nearly one point from end May. Deutsche Bank (ETR) stated that rates are now at a peak of 4.125% by mid-2020.

One sign that the world fixed income market is in turmoil, the credit default swap indexes which measure the cost to insure against European corporate bond defaults, jumped Monday to the highest level since 2020.

U.S. corporate debt was also criticized for its economic outlook, and the ability of companies to pay back their debt.

Rabobank said that “stagflation”, an era of high inflation and weak growth, last experienced in the 1970s, may lead to the possibility of “incession”, the combination of inflation and recession.

Capital Economics’ Oliver Allen stated that rising credit spreads and the shape of the Treasury yield curve Inversion indicate growing concerns about the economic outlook.

In a note, he stated that “one interpretation is that investors tend to believe that the Fed must induce recession in order to bring down inflation to target.”