Fed Faces Close Call as Market Pricing Points to Rate Hike in July

BNY strategists John Velis and David Tam anticipate that the Federal Reserve (Fed) will maintain the federal funds rate unchanged at its upcoming July meeting. However, they acknowledge it's a close call, with market pricing indicating a one-in-three chance of a hike this week.

The strategists highlight that market expectations suggest at least one rate hike by September and see future moves driven by incoming US inflation data and Middle East-related energy shocks. They note that many observers have commented on the market already being primed for slightly higher rates by fall, but they don't find this answer compelling.

Velis and Tam stress that implied rate hike probabilities can switch quickly due to uncertainty in the geopolitical situation in the Middle East. With recent hostilities resumed, energy prices and inflation expectations may adjust rapidly. They expect many energy-related components to push higher, including those elements of supercore impacted by supply chain shocks.

The strategists believe it's prudent for the Fed to wait and see both the depth and breadth of renewed higher energy prices on aggregate indices before making any decisions. If the Fed holds rates steady, they expect a market reaction depending on how such a hold is presented, whether as a 'hawkish hold' or with reticence by the new Chair.