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Markets weigh the chances of a surprise Fed rate hike
Economy
In less than 24 hours, the Fed will announce its interest rate decision. While the consensus forecast is for rates to remain unchanged, a number of market participants are expecting a surprise hike.
Citadel Securities is among these "outlier" forecasters: Frank Flight, head of macro strategy at the firm, expects a 25 basis point hike. Overall, 32% of market participants expect a hike tomorrow. This is lower than yesterday, but sharply higher than a week ago.
The rise in the likelihood of a hike—from about 16% a week ago—comes amid the June-July surge in oil prices, which briefly pushed Brent above $100 per barrel due to escalating US-Iran tensions. WTI is currently trading at $79.31, down nearly 4% during Tuesday's session, which may reduce the urgency of the Fed's action somewhat. The context of Warsh's second meeting as chairman is particularly opaque. Unlike his predecessor, Jerome Powell, Warsh has deliberately abandoned the practice of forward guidance, depriving markets of the familiar signaling cues they had become accustomed to over the past decade. Inflation in June was 3.5% year-on-year, down from 4.2% in May but still well above the Fed's 2% target, and the base rate has been held between 3.50% and 3.75% since December.
Advocates of a rate hike primarily appeal to arguments about the Fed's credibility. Citadel Securities sees such a move as a way to bolster Warsh's reputation as an inflation-fighter. According to Flight, the hike would "definitively end the era of forward guidance" and underscore the Fed's independence. Neil Datta, chief economist at Renaissance Macro Research, expressed a similar view in a client note dated July 22, cited by Business Insider: "You have to be smart about when to go against the consensus, and I think this is a good time. Most FOMC members are ready to hike in September. It may be far better to act now, while we have the opportunity, and demonstrate some control over the decision-making process, than to do so in September when there are few options left."
Strategists at UBS Global Research said they "wouldn't be surprised if rates were hiked... to demonstrate resolve in the fight against inflation."
Wrightson ICAP analysts went further, telling Reuters that the decision "could go either way," but they believe the Fed is "more likely to hike by 25 basis points on Wednesday than leave rates unchanged," adding that Warsh would face minimal resistance if he insisted on tightening. Those who favor maintaining the rate hold have their own logic, based on the risk of sequencing. Former St. Louis Fed President James Bullard put it bluntly: "It's not typically a one-time hike, so the committee will have to decide whether it's willing to commit to a series of hikes. I don't think they're willing to do that at this meeting." In other words, once the Fed begins a tightening cycle, it rarely limits itself to a single move.
Mark Cabana of Bank of America noted that, according to federal funds futures data dating back to 1994, the Fed has never raised rates when the market priced in less than a 60% probability of such a move. Such a hike would be "unprecedented," he said.
The stock market is taking the uncertainty with relative calm. The S&P 500 is currently trading at 7,440.96, up 0.37% on the session, although the risk of a rate hike is significantly limiting gains. The VIX is at 18.06, down 3.27% for the session, but still well above recent lows, consistent with heightened macroeconomic uncertainty ahead of tomorrow's decision.
Beyond the binary outcome of whether to hold or raise rates, the wording of Wednesday's FOMC statement itself carries an important signal. Analysts are closely watching whether the Fed will maintain or remove the phrase "closely monitoring inflation risks," which could indicate how the September meeting is being prepared. Warsh's press conference at 10:30 PM Moscow time on Wednesday will be the main market event following the decision announcement at 10:00 PM Moscow time, given his departure from Powell's forward-looking approach.