The Federal Reserve will hold its policy meeting on July 28-29. Against the backdrop of an oil price rebound, rising demand driven by artificial intelligence, and new tariff measures introduced by the Trump administration, the core issue facing this meeting is shifting back to whether a rate hike is necessary.
The June inflation data, which had previously eased market sentiment, has been partially overshadowed by the latest price pressures. Data released by the Labor Department on July 14 showed that the U.S. Consumer Price Index (CPI) fell month-over-month for the first time in six years in June, driven by lower gasoline prices. However, as tensions in the Middle East escalate again and crude oil prices rise, market concerns about persistent inflation have quickly resurfaced.
At last week's close, federal funds rate futures showed that investors priced in roughly a 35% probability of a rate hike this week. This probability had briefly dropped to around 10% following the release of the June CPI data. Subsequently, bets on a rate hike re-emerged due to renewed fears of an escalation in the war with Iran.
Pricing in the interest rate swap market is closer to the higher end. Traders see an approximately 37% chance that the Fed will raise rates by 25 basis points this week, with the remainder of the probability betting on the central bank holding rates steady. Meanwhile, traders have fully priced in a rate hike by September. In contrast, a Bloomberg survey shows that nearly all economists expect the Fed to hold rates unchanged this week.
"The market is adjusting to the risk that inflation proves more sticky due to these geopolitical issues," said Alex Payne, Senior Portfolio Manager at Vanguard Group.
Fed's Internal Divisions on Rate Hikes Intensify
Voices supporting tighter policy have become more vocal within the Fed recently. Dallas Fed President Lorie Logan earlier this month advocated for "moderate" rate hikes, arguing that inflation has not sustainably returned to the Fed's 2% target.
Cleveland Fed President Beth Hammack also said recently that there is "no conflict" between the Fed's dual mandate, and that currently, inflation is more concerning than employment.
Both officials have voting rights this week. If the final decision is to hold steady, they could cast dissenting votes.
"It's clear from the Fed officials' speeches that a small group—like Logan and Hammack—might be ready to act. And then there's a sizable group that wants to see more improvement, and quickly," said Claudia Sahm, Chief Economist at 新世纪 顾问公司 (New Century Advisors LLC).
This divergence was already evident at last month's meeting. Although officials held policy steady for the fourth consecutive time, the meeting minutes showed that several policymakers saw a case for raising rates. Most officials also discussed scenarios where inflation could remain persistently high, including AI-related demand, the Middle East conflict, and tariff impacts. Nearly all participants in these discussions believed that if these scenarios materialized, rate hikes would likely be necessary.
Since then, the associated risks have not diminished. The Trump administration has announced new tariffs on Canada and other trading partners. The fragile ceasefire between the U.S. and Iran has broken down. Meanwhile, the strong momentum in AI investment shows little sign of slowing.
Fed Vice Chair Philip Jefferson said two days after the CPI report: "In a scenario where inflation doesn't actually start to cool down soon, I think it might be appropriate to reconsider our current policy stance."
Warsh Offers No Pre-Announced Path, Markets Hedge on Both Sides
Fed Chair Kevin Warsh reiterated on Capitol Hill this month that the central bank will use its tools to achieve price stability but did not specify how those tools would be deployed. By no longer providing a clear policy path in advance, he has broken from the Fed's long-standing practice of forward guidance on the interest rate outlook, making this meeting the most unpredictable in years, according to the market.
"About a third of the banks we work with are preparing for a rate hike, while the rest are hedging for a rate cut. That divergence tells you that the market is no longer trying to predict the Fed; it's starting to prepare for both outcomes," said Pradeep Bhatia, CEO of Derivative Path.
Citigroup economist Veronica Clark believes that given the relatively mild June inflation data, officials may still be inclined to hold rates steady this week. In her view, if subsequent data shows limited passthrough of higher energy prices and a rise in unemployment, policymakers could extend the pause or even pivot to rate cuts.
However, some officials, while advocating for a wait-and-see approach, have also made it clear that rate hikes could still occur at future meetings if price pressures persist. In other words, inaction this week does not mean the tightening risk has disappeared.
Joseph Lavorgna, Chief US Economist for the Americas at SMBC Nikko Securities, offers another perspective. He argues that a rate hike this month would allow Warsh to establish his anti-inflation credibility, and that acting now would be less politically charged than adjusting rates closer to the November midterm elections.
Trump criticized former Fed Chair Jerome Powell for cutting rates by 50 basis points in September 2024, just weeks before the presidential election, calling it a "political move" to help his opponent, Kamala Harris.
"If you wait until September, or heaven forbid, October—on the eve of the midterms—to do your first rate hike, what does that look like? He might as well hike now," Lavorgna said. He also suggested that Warsh could explain the rate hike as a way to lower inflation expectations and thereby help bring down long-term market interest rates, a key concern of Trump's, potentially appeasing the president.
Bond Yields Rise, Meeting Outcome Impacts Broader Markets
The bond market has already reacted to this uncertainty. The benchmark 美国10年期国债收益率 rose 13 basis points last week to 4.71%, its highest level since early 2025. The 30-year Treasury yield touched 5.19%, approaching 20-year highs.
"Traders are currently judging that the 'inflation story isn't over yet, so we are pushing bond yields higher. When Warsh is silent, the bond market screams,'" said Charles Tan, Chief Investment Officer for Global Fixed Income at American Century Investments, on Bloomberg Television.
Matthew Luzzetti, Chief US Economist at 德意志银行 Securities, believes the key question for the upcoming meetings is "where the center of gravity of the committee lies on the issue of whether a rate hike is needed."
Regardless of whether the Fed chooses to hike or hold this week, Chair Warsh's remarks at the post-meeting press conference will be crucial for the market to gauge the future path. What truly drives asset pricing now is not just this meeting itself, but how the Fed defines the current resurgence of inflationary pressures.
