The combined impact of surging oil prices and hawkish signals from Federal Reserve officials is pushing market expectations for a July rate hike to a critical juncture.
On Monday, pricing in money markets indicated that the probability of a 25-basis-point rate increase by the Fed this month has climbed to nearly 50%, up from a previous level below 40%. This shift was driven by the clearest hawkish signal yet from Fed Governor Christopher Waller, who stated that if this week's inflation data comes in hot again, the FOMC would need to consider tightening monetary policy in the near term. Concurrently, escalating geopolitical tensions sent Brent crude oil soaring by nearly 10% in a single day, further intensifying market concerns about persistent inflationary pressures.
U.S. Treasury yields subsequently moved higher across the curve. The policy-sensitive 2-year Treasury yield rose approximately 7 basis points to 4.28%, its highest level since February 2025. The 10-year yield climbed to 4.62%, reaching a new high since May.
Market focus this week will be squarely on Tuesday's release of the U.S. June CPI data and congressional testimony from Fed Chair Kevin Warsh. These two events are widely seen as having a decisive influence on the policy direction for the July 29th FOMC meeting.
Waller Sets Conditions for Rate Hike
Waller's comments on Monday were interpreted by the market as the clearest warning signal yet regarding a potential rate increase.
He explicitly stated that if core inflation data this week comes in hot again, the Federal Open Market Committee would need to consider tightening monetary policy in the near term.
Waller noted that the Fed's preferred inflation gauge, the core Personal Consumption Expenditures (PCE) index excluding food and energy, had risen 3.4% year-over-year through May and has been trending upward since January, even before the outbreak of U.S.-Iran conflict. He cited factors including tariffs, energy prices, and massive investment in AI infrastructure as drivers of inflationary pressures. "By any measure, inflation has been rising this year," he said, adding that he is currently concerned about the high trajectory of core inflation.
Waller's stance aligns with the direction indicated in last month's FOMC meeting minutes, which showed that half of the 18 policymakers now anticipate at least one 25-basis-point rate hike at some point this year, moving the option from the periphery toward the center of policy discussions.
Simultaneously, a sudden flare-up in geopolitical tensions has added fuel to inflation expectations. Following a new round of military exchanges between the U.S. and Iran, Brent crude oil surged as much as 9.9% in a day, with conflicting statements from both sides regarding the status of the Strait of Hormuz. Comments from former President Trump about the U.S. "reinstating" a blockade on Iranian vessels further heightened market fears of a global energy supply disruption.
The sharp rebound in energy prices directly reinforced the market's view that inflationary pressures may be difficult to subside. This, combined with Waller's hawkish tone, prompted a rapid repricing of short-term interest rate expectations.
CPI and Warsh Testimony Emerge as Key Variables This Week
This week's policy signals will be concentrated around two key events. The market expects the June CPI year-over-year rate to slow to 3.8% from 5.2% in May, though it remains well above the Fed's 2% target. Core CPI is also forecast to ease slightly but stay elevated.
Market participants indicated that the upward adjustment in near-term rate hike expectations is a direct reaction to Waller's comments. This makes Tuesday's CPI data even more critical and potentially more volatile—a hot reading could risk further bearish flattening of the yield curve.
Meanwhile, Fed Chair Kevin Warsh will appear before Congress for the first time in his new role this week. Having previously pledged to reduce forward guidance on the rate path, his testimony will be closely parsed by the market.
Investors continue to focus on the July 29th FOMC meeting as a potential window for Warsh's first rate hike. The combination of Tuesday's CPI data and Warsh's testimony is likely to significantly shift the probability of a hike in one direction or another.
Despite the probability nearing 50%, the baseline expectation for most investors remains no rate hike this year.
Waller also stated that if a lower core inflation reading is seen, he would support holding policy steady. However, he set a condition, saying that after persistent inflation increases in the first half of the year, he would need to see several consecutive months of cooling data to be confident inflation is moving in the right direction.
Furthermore, Waller explicitly referenced policy mistakes during the pandemic-era inflation surge as a cautionary tale, warning that the FOMC was widely criticized for being too slow to hike rates then, a mistake that should not be repeated. He stated the FOMC must be prepared to tighten policy to prevent a repeat of the 2021-2022 inflation episode.
One macro strategist pointed out that Waller's Monday remarks effectively clarified the Fed's reaction function, delivering a hawkish signal while also reducing the market's uncertainty premium around the Fed's policy path.
Analysis suggests this means this week's data and testimony will largely determine whether the market needs to further reprice its rate hike expectations.
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