In this segment of "Ask Us Anything" on Motley Fool Live, recorded on Feb. 28, Fool.com contributors Matt Frankel and Dan Caplinger discuss how much of rising inflation and interest rate risk is already priced into the market and how much uncertainty there is going forward.
Matt Frankel: The short answer is, I think there's quite a bit priced in already. We've already pretty much thrown out the view that inflation is transitory at this point. The Fed even admitted that that was the wrong word to use. As far as interest rates go, you'd be surprised how much is already being predicted.
I want to share my screen, one second. This is something that the CME, which is the biggest futures trading exchange, puts out. It's called their FedWatch Tool if you can see that OK. If you Google CME FedWatch Tool, you'll find this. If you see these tabs along the top, this shows the probability that the market is pricing in options traders, that is. The market is pricing in for future interest rate hikes at any given date.
This is the March meeting which is coming up very shortly, the overwhelming expectation over 90% is priced in of one Fed rate hike this time around. If you look at some of these other dates, by the time the May meeting rolls around, we're expecting about two rate hikes with a smaller probability of three, if you look on the bottom there, and you can go all the way out to 2023, which they're expecting, there's much more of a distribution then.
This is where the uncertainty part of it comes into that I was mentioning. Where you can see it's much more of a distribution as time goes out. To answer the question, as far as short-term rate hikes and inflation goes, there's less uncertainty than there is priced in goods. As you get further out, the uncertainty gets much, much greater.
Right now, the most likely probability in mid-2023 is a federal funds rate in the 2% ballpark. But as you can see, there's a giant distribution there. There is a lot of uncertainty when you go out a year or so. If you think inflation can't get much higher than the 7 or 8% range it is right now, don't be so sure of that. Dan mentioned the 1980s a minute ago, which is the go-to that everyone mentions when you talk about high inflation.
But it's also worth mentioning that the highest inflation period in our modern history took place toward the end of the Spanish Flu pandemic in 1918-1920. This inflation caused by a global pandemic isn't entirely unprecedented and peaked in the 20% range. If you think 7% is as high as it can go, don't be so sure about that. But as far as uncertainty, I'd say there's quite a bit when you go out a year or two.
Dan Caplinger: It's been an interesting look at the treasury yield curve. A lot of folks have been looking at the 10-year rate, the 30-year rate. But I think a lot of what you're talking about as far as short-term expectations, you look at the three-month bill or six-month bill, one-year, two-year rates, they've really jumped up high.
That is like Matt showed on that chart, is reflecting the possibility, not just that we see a larger number of Fed rate hikes in the next 12 months. But that they may not all be quarter-point rate hikes that you might see some accelerated monetary policy tightening coming up in the next 12 months. Just to get us back on an even keel and deal with some of these extraordinary factors that we're dealing with in the market.
