The Federal Reserve is highly likely to keep interest rates unchanged today, but this could be the most turbulent 'pause' in recent memory. Money markets are pricing in a 32% probability of a rate hike, with UBS economists describing the level of uncertainty as the highest in two decades. Internal hawkish divisions are widening, and the policy stance of Governor Walsh remains an enigma. Institutions like Citadel have already made clear bets on an additional rate increase. According to Goldman Sachs' calculations, if the Fed raises rates by 25 basis points, the S&P 500 could plunge by more than 2%—tonight, even 'no change' itself could trigger a shockwave.
Today's Federal Reserve decision is likely still a "hold," but the market's true concern isn't the baseline scenario—it's a rare surprise rate hike, or a pause with sufficiently hawkish language.
The Federal Reserve will announce its latest rate decision. This meeting will not include a dot plot or economic projections, and the federal funds rate target range is expected to remain at 3.50%-3.75%. According to a Reuters poll, all 104 economists surveyed expect no change in rates. However, money markets still price in about a 32% probability of a rate hike this week, and incorporate roughly 42 basis points of tightening over the year, making this the most "uncertain" meeting in recent years.
The uncertainty stems from a tug-of-war between two forces. The June CPI came in lower than expected across the board, nonfarm payrolls were weaker than anticipated, and oil prices fell ahead of the meeting, all giving the Fed room to wait. But inflation remains above the target, the Middle East situation and oil prices are volatile, some Fed officials have recently sounded hawkish, and Chairman Warsh has yet to establish a clear policy track record, making it difficult for the market to completely rule out the risk of a rate hike.
Jonathan Pingle, Chief U.S. Economist at UBS, said, the level of uncertainty he feels about the upcoming Fed decision is the highest in 20 years—the last time he felt similarly was when Ben Bernanke had just taken over as Fed Chair. "Warsh will dominate policy direction in the coming meetings, and we know almost nothing about how he views monetary policy."
For investors, the risks are concentrated in short-end rates, the dollar, and the immediate reaction of U.S. stocks. According to J.P. Morgan's Market Intel, if the Fed unexpectedly hikes by 25 basis points, the S&P 500 could fall 1.5%-2%; if it hikes by 50 basis points, the decline could widen to 2%-4%. Even if rates are held steady, a hawkish statement and press conference could limit the rebound in risk assets.
Market Consensus is a Pause, but Pricing is Not Calm
From a traditional forecast perspective, this decision seems straightforward. According to the Reuters poll, all 104 economists expect the Fed to hold rates steady. Of those, 78 expect no adjustment in rates for the rest of the year, and only 6 expect a rate cut.
But the same survey shows that 66% of respondents believe the likelihood of a rate hike this year is "high," a significant shift from the "low" consensus in June. Market pricing also suggests investors are paying for the tail risk of a hike. Traders are not only pricing in roughly a 30% chance of a hike this week but are also fully pricing in a 25-basis-point hike by September and close to 50 basis points of tightening by March next year.
Goldman Sachs believes this pricing makes the outcome of this meeting "unusually uncertain." If the Fed hikes, it would be a rare unexpected action; if it doesn't, the market will quickly reassess the previously priced-in risk of a hike. Ian Lyngen of BMO Capital Markets noted that since 2015, traders' average error on the final rate decision the day before a Fed meeting has been only 2.4 basis points, but this time, the market is more prone to a sharper-than-usual immediate reaction.
Data Supports Waiting, but Inflation Risks Remain
The case for a Fed pause mainly rests on the latest data. The June CPI came in below expectations, dampening the rate hike bets triggered by Waller's earlier hawkish comments. Waller had said that if June core CPI came in hot, a near-term rate hike should be considered; if it came in cold, he would need to see more similar readings before treating it as a clear signal.
The labor market is also giving the Fed more time to observe. June nonfarm payrolls were weaker than expected, with prior months revised down, resulting in a net downward revision of 74,000 jobs over two months, compared to a previous increase of 93,000. While the unemployment rate fell slightly, data suggests this may be mainly due to a decline in the overall labor force participation rate.
Oil prices are also a key variable. The conflict between the U.S. and Iran escalated after the last meeting, with relevant memoranda of understanding violated and both sides launching new strikes. However, over the weekend before the meeting, strikes paused, the geopolitical risk premium declined, and oil prices fell accordingly, helping to ease inflation expectations. Fed officials had previously cautioned against reacting too quickly to what might be temporary supply shocks.
The problem is that underlying inflation remains significantly above the target. Morgan Stanley points out that upside risks include persistently high oil prices, a more hawkish Fed reaction function, and AI-driven investment pushing up the neutral rate. Goldman Sachs also believes that the combined impact of tariffs, war, and AI statistical errors on monthly inflation may diminish in the future, but uncertainty remains high. Once the improvement in inflation stalls, discussions about rate hikes within the Fed will reignite.
Communication in the Warsh Era is a Risk in Itself
The last FOMC meeting chaired by Warsh was also his first. At that time, the statement was significantly shortened, forward guidance language was removed, and the committee's commitment to bringing inflation back to the 2% target was strengthened. This means that even subtle wording changes this time will be amplified by the market.
Morgan Stanley expects the statement to remain largely unchanged this time, including reiterating the "ample reserves" policy, describing economic activity as expanding "at a solid pace" amid high uncertainty, the unemployment rate as "little changed," and inflation as remaining "elevated." With no Summary of Economic Projections this month, policymakers have no need to reset market expectations through the dot plot.
The press conference may be more important. Warsh is expected to be asked about the impact of the Middle East conflict on inflation, the newly announced Chairman's Working Group, and whether the latest data will bring forward the timeline for policy action. Goldman Sachs expects Warsh to avoid giving clear policy signals, likely emphasizing that all options remain open and future decisions depend on the data.
Credit Agricole believes the Fed is entering a new phase with more limited forward guidance, which will turn more meetings into genuinely "live" ones. The bank expects the Fed to remain on hold this time and believes the data since the last meeting has at least bought time for a continued pause. Regarding the five new working groups established by Warsh, Credit Agricole does not expect major updates in the near term, with recommendations likely not completed until close to year-end, which also means balance sheet policy is unlikely to change in the near term.
Divergence Widens, a Pause Could Also Come with Dissent, Watch for Dissenting Votes
The internal divergence within the Fed is the core of the uncertainty at this meeting. In the June projections, 9 of the 18 participants who submitted forecasts expected at least one rate hike this year. Since then, comments from several officials have indicated they are willing to consider further tightening if the disinflation process stalls.
Waller and Cook have both said they might consider tightening policy if the disinflation process stalls. 2026 FOMC voters Logan and Hammack have sounded more hawkish. Logan has argued for a moderately higher policy rate to better balance the outlook and risks, and believes some restrictive policy is still needed to help bring inflation back to target. Hammack directly stated that the Fed might need to consider a rate hike.
Therefore, even if rates are held steady, dissenting votes are possible. Based on recent comments alone, if the Fed chooses to pause, there could be 2 to 4 dissenting votes in favor of a hike. Goldman Sachs expects the statement to acknowledge the upside risks to inflation from geopolitical conflicts and may see at least one member voting for a rate hike.
Mark Cabana, an analyst at Bank of America, expects the Fed to hold rates steady on Wednesday but may attract dissenting votes from regional Fed presidents like Lorie Logan and Beth Hammack. He also said that as long as the market does not rule out the risk of a rate hike, strategists will not either.
A Few Institutions Bet on a Rate Hike "Scare"
Despite the mainstream view being a pause, some institutions are explicitly betting on an outside rate hike. Citadel Securities stands out as a notable outlier, with its Head of Macro Strategy, Frank Flight, changing his baseline scenario this week to a 25-basis-point hike. He believes this would strengthen Warsh's credibility in fighting inflation and "decisively end the era of forward guidance."
Robert Tipp, Head of Global Bonds and Chief Investment Strategist at PGIM, also said the market may be underestimating the probability of action on Wednesday. He believes Warsh has essentially set the stage for a rate hike, and delaying the decision now could increase the probability of a 50-basis-point hike in September.
Lou Crandall, Chief Economist at Wrightson ICAP, said the Fed has no strong reason not to hike. Bond market veteran Harley Bassman even argued that the Fed should hike by 50 basis points in one go to strengthen its anti-inflation credibility.
However, Goldman Sachs still believes most FOMC members are unlikely to push for a rate hike this week after the soft June inflation data. The bank also notes that the Fed has historically avoided surprising rate hikes at meetings, especially those without a Summary of Economic Projections, as officials may be more concerned about the market overinterpreting their intentions.
Asset Reaction: A Rate Hike is the Biggest Shock, a Hawkish Pause is Not Easy Either
J.P. Morgan's Market Intel lists a "hawkish pause" as the baseline scenario, with a 50% probability. In this scenario, the S&P 500 could rise 0.25% to fall 0.50%. The logic is that the Fed will pause due to resilient labor markets and growth, but continue to stress vigilance on inflation.
In the event of an unexpected 25-basis-point rate hike, J.P. Morgan expects the S&P 500 to fall 1.5%-2%, with the Nasdaq 100 potentially falling more. If it were a 50-basis-point hike, the S&P 500 could fall 2%-4%. In a "dovish pause"—holding rates steady with conciliatory communication—the S&P 500 could rise 0.50%-1%. In the options market, options expiring on July 29 price in about 0.8% volatility for the S&P 500, lower than the roughly 1.1% pricing for recent CPI events.
In FX, the Goldman Sachs FX team believes that if the Fed pauses, the dollar could see a tactical weakness, but as long as energy prices remain high, this weakness could be short-lived. In the medium term, if the Fed holds rates steady for the rest of the year as the bank's economists expect, it would put modest but manageable pressure on the dollar against G10 currencies.
The focus in the rates market is on the front end. Goldman Sachs' rates desk believes the market may misinterpret the "lack of forward guidance" as deliberate ambiguity. The desk leans toward the view that if the Fed Board does not support a rate hike, the hawkish voters do not have enough votes to push for action this week. However, if the Fed pauses in July, Warsh could still deliver a hawkish pause and pave the way for a September rate hike.
In commodities, Goldman Sachs' crude oil desk says the risk premium for oil is fading rapidly, as the U.S. and Iran have formed a de facto ceasefire over the weekend, and negotiations to reopen the Strait of Hormuz are progressing. But upside risks have not disappeared; if attacks on Saudi oil facilities or production continue, oil prices could rise again. Gold has been trading in a roughly $250 range over the past two months, and the desk maintains a long-term bullish view but favors tactical trading around news events.
This means that today's key is not just whether rates change, but how Warsh explains the "no change" or "change." Against the backdrop of the market having already paid for the risk of a rate hike, and economists almost unanimously expecting a pause, no matter which side the Fed chooses, it could deliver a significant shock to the market.
