With the Federal Reserve's July policy meeting approaching, uncertainty over its policy path has significantly increased under the new leadership of Chairman Warsh. Just days before the meeting, a notable divergence persists in the market regarding whether the Fed will raise interest rates this month, a situation that has been rare in recent years. The interest rate swap market indicates traders currently assign about a 30% probability to a 25-basis-point hike announcement on July 29, with a roughly 70% chance of rates remaining unchanged. Market observers suggest that such pronounced expectation splits on the eve of a policy meeting may become the new norm in the Warsh era.
Jim Bianco, President and Macro Strategist at Bianco Research, noted that the removal of forward guidance means the market will frequently see probabilities of 20%, 30%, or even 40% for rate hikes or cuts, reflecting investors' adaptation to the Fed's new communication style. The last time the market was this divided over a Fed meeting outcome was in September 2024. At that time, investors were split on whether the Fed would cut rates by 25 or 50 basis points; then-Chair Powell ultimately opted for a 50-basis-point cut to address a weak U.S. labor market.
Since assuming the role of Fed Chairman in May this year, Warsh has repeatedly expressed a desire to end the Fed's long-standing practice of using forward guidance to signal future rate paths in advance. He believes that in a rapidly changing economic environment, pre-releasing policy signals could limit the flexibility of policymakers. For financial markets, this implies that the risks and potential rewards of betting on the Fed's policy direction have both increased, with correct predictions potentially yielding higher returns and incorrect ones leading to greater losses.
However, Warsh has consistently emphasized that U.S. inflation has remained above the Fed's 2% target since the COVID-19 pandemic. Consequently, the market widely expects the Fed to resume rate hikes within the year, with the primary uncertainty now being the timing of such action.
Compared to traders, economists show greater consensus. A survey shows that all 76 economists polled expect the Fed to maintain the federal funds rate target range at 3.5% to 3.75% during its July 28-29 meeting. In fact, data released last week showed the U.S. Consumer Price Index (CPI) fell month-over-month in June for the first time in six years, initially prompting bond markets to bet the Fed would hold steady.
However, with the recent escalation of U.S.-Iran tensions pushing international oil prices higher again, concerns about renewed inflationary pressures have resurfaced, also strengthening expectations for a rate hike. Currently, the interest rate swap market has fully priced in a 25-basis-point hike by the Fed in September and anticipates cumulative hikes exceeding 50 basis points by next March, implying market expectations for more than two additional hikes.
John Brady, Managing Director at RJ O'Brien, stated that while he personally still believes the Fed will not hike rates next week, market pricing suggests the policy decision at this meeting will be closer than he previously anticipated, leaving the outcome with a degree of suspense.
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