The Federal Reserve is scheduled to hold its policy meeting on July 28-29, local time. As the meeting approaches, the swap market indicates traders are pricing in roughly a 30% chance of a 25-basis-point rate hike this month, with a 70% probability of rates remaining unchanged.
Economists show much greater consensus, with all 76 economists surveyed by Bloomberg forecasting the Fed will maintain borrowing costs within the current 3.5% to 3.75% range.
Data released last week showed the U.S. June CPI monthly rate turned negative for the first time in six years, leading bond traders to initially align with the view of unchanged rates. However, as tensions between the U.S. and Iran escalated again, pushing oil prices higher, expectations for a rate hike have gradually increased.
Interest rate swaps are now fully pricing in a 25-basis-point hike by the end of September and indicate the Fed will raise rates more than twice by March of next year.
Nevertheless, John Brady, managing director at RJ O'Brien, remains unconvinced that action will be taken at the July meeting. "I still don't think the Fed will hike next week, but the market is telling me this decision is much more uncertain than I had anticipated," he said.
The last time the market held a similar level of disagreement over a Fed meeting outcome was in September 2024. Back then, traders were unsure whether the Fed would cut rates by 25 or 50 basis points, with Powell ultimately opting for the larger cut to support a weakening labor market.
Warsh Alters Communication, Market Loses Clear Guidance
The current market pattern suggests Warsh is already leaving his mark on financial markets.
Since taking office in May, Warsh has consistently promised to end the Fed's practice of pre-signaling its interest rate path. He believes that forward guidance unnecessarily constrains policymakers as economic conditions evolve.
"No forward guidance means we will frequently see 20%, 30%, 40% probabilities of a rate hike," said Jim Bianco, president and macro strategist at Bianco Research, adding, "The market is transitioning to this new way of thinking."
With less pre-meeting guidance, traders who correctly predict the Fed's actions may reap greater rewards, while those who misjudge could face larger losses. Significant market disagreement persisting right up to a meeting is likely to become more common under Warsh's leadership.
Warsh has made it clear that controlling inflation, which has remained stubbornly above the Fed's target since the pandemic, is necessary. This has led traders to believe the Fed will hike rates by year-end, with the main debate focusing on the precise timing.
Last week, Warsh testified before Congress for over five hours across two days but offered little specific guidance for the July meeting. He pledged that an "internal family debate" would take place within the Fed to reach the best decision.
By reducing policy pre-announcements, Warsh has preserved greater flexibility for interest rate decisions. This flexibility was notably diminished under previous Fed chairs, who often telegraphed rate moves well in advance.
Simultaneously, Warsh has ceded some of the Fed's power to set market expectations. Traders are left to fill information gaps from other Fed officials' comments, increasing the risk of future policy surprises and market volatility.
Multiple Officials Hint at Holding Rates, Dissenting Votes Possible This Month
Fed Governor Waller stated on July 13 that upcoming June inflation data might push him to support a near-term hike. However, the ultimately soft data suggests Waller will likely maintain a patient stance.
Two days later, Fed Governor Cook remarked, "If we don't soon see signs of inflation slowing, I am prepared to act." This indicates her current willingness to hold rates steady but a very low tolerance for inflation, suggesting she could quickly pivot to support a hike.
Vice Chair Jefferson stated last Thursday, "Should actual inflation not begin to cool soon, I believe it may be appropriate to reconsider our current policy stance to ensure we fulfill our commitment to price stability."
With no major inflation data scheduled between Jefferson's remarks and the July policy meeting, his comments suggest a temporary disinclination to adjust rates. However, the Fed would be highly alert to changing its policy course if July and August inflation data run hot.
The specific role Jefferson will play under Warsh's leadership is still becoming clear. As this message comes from the Fed's number two official, it carries significant policy weight.
Some officials have already signaled potential dissenting votes. Dallas Fed President Logan expressed a preference for a "modest increase" in rates.
On the final day before the Fed entered its pre-meeting quiet period, Cleveland Fed President Harker published remarks noting that her business contacts see inflation as "broad-based." She also stated she would attend the meeting with an open mind.
These statements point towards a likely July meeting outcome: holding rates steady, with several dissenting votes, and a warning that inflation must decline, or a rate hike later this year remains a distinct possibility.
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