Market expectations for the Federal Reserve to raise interest rates have continued to intensify. According to the CME Group's FedWatch tool, the probability of a 25-basis-point rate hike at the Fed's July 29-30 meeting has risen to 46.5%, up from 34% on Sunday. On the prediction market platform Kalshi, traders now assign a 36% chance of a Fed rate hike, higher than the less than 20% level on Sunday and significantly above the sub-10% probability seen at the beginning of the month.
The surge in rate hike bets coincides with heightened geopolitical tensions. Following the U.S. administration's announcement of renewed sanctions targeting Iranian ports near the Strait of Hormuz and the imposition of a transit fee on cargo passing through the strait, renewed U.S.-Iran friction has pushed international oil prices higher. This development has amplified market concerns that inflation could remain elevated for longer, potentially forcing the Federal Reserve's hand on interest rates.
Consequently, investors are keenly awaiting the upcoming release of key U.S. inflation data for June, including the Consumer Price Index and wholesale price figures. These reports represent the final batch of inflation data before the Fed's policy meeting later this month and are expected to provide crucial insights for assessing the future interest rate trajectory.
Economists anticipate that both the headline CPI and the core CPI, which excludes food and energy prices, will show a slight deceleration in their year-over-year growth rates for June compared to May. The headline CPI is forecast to rise 3.8% year-over-year, down from the 4.2% increase seen in May. However, both measures are expected to remain significantly above the Fed's 2% inflation target.
Inflation Concerns Broaden Beyond Energy
A research report from Barclays noted that current market inflation worries extend beyond just energy prices. Ajay Rajadhyaksha, Global Head of Research at Barclays, stated that the cost-push effects stemming from the oil price shock are not yet complete. Furthermore, persistently high energy prices without a corresponding significant demand reduction are adding to inflationary pressures. He also highlighted that price increases driven by artificial intelligence (AI) are further worsening the inflation outlook.
Rajadhyaksha wrote that these combined factors create a scenario where the Federal Reserve may be compelled to adopt an increasingly hawkish policy stance. He remarked, "A data-dependent policy framework means the Fed must react to both released inflation data and future inflation forecasts." He added, "The inflation data released over the next few months is unlikely to look favorable."
Fed Officials Signal Cautious Stance
Federal Reserve Chairman will testify before Congress on Tuesday and Wednesday. Fed watchers will closely analyze his views on inflation, the labor market, economic growth, and their interplay with interest rates. However, based on his recent public appearances, observers may gain limited new insights. The Chairman has committed to moving away from the central bank's so-called "forward guidance" regarding future rate paths. During his first press conference on June 17, he avoided direct answers to several related questions. For instance, when asked about policymakers' patience in waiting for inflation to subside, he responded, "Your question sounds like an invitation to provide forward guidance."
Separately, Fed Governor Christopher Waller stated on Monday that while the current U.S. inflation situation remains concerning, the Fed should not rush to hike rates again merely because of lessons learned from its delayed response in 2021. Instead, he advocated for waiting for more economic data to assess inflation trends and their underlying drivers.
In a speech in New York, Waller noted that current inflationary pressures are no longer solely from tariffs and rising energy costs but are also influenced by factors like demand expansion driven by AI investment, which is a key reason inflation remains above the Fed's 2% target. He emphasized, however, the need to avoid repeating past mistakes. Waller said, "I am deeply aware of the mistake we made in 2021 by not responding to high inflation in a timely manner, and I am determined not to repeat the same error. But that does not mean we should immediately raise interest rates in the face of current inflationary pressures."
Waller believes there is still "good reason" to expect inflation to gradually decline in the future, but he also acknowledged a "perfectly reasonable" scenario where inflation remains high or even rises further, necessitating additional policy tightening in the near term. He pointed out that the Fed is currently evaluating multiple factors driving inflation, including tariff policies implemented in 2025, energy price increases due to Middle East tensions, and demand spillover effects from AI investment. "We cannot tighten policy prematurely just because we acted too slowly last time, nor can we repeat the 2021-2022 mistake of acting too late again in response to inflation," Waller stated.
Waller identified two favorable conditions for the Fed compared to the last inflation cycle: a still-resilient labor market that is not a primary source of inflation pressure, and overall stable long-term inflation expectations, with market-based indicators still showing public confidence in long-term price stability. Nevertheless, he warned that policymakers cannot become complacent. Waller concluded, "I often hear the argument that as long as inflation expectations remain anchored, the central bank does not need to react to inflation above target. That view is wrong. Simply watching inflation and hoping it comes down on its own is not a viable policy option."
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