Fed Decision Eve: 104 Economists Expect No Change; Why Is Citadel Securities Betting on a Surprise Hike?

TradingKey - The Federal Reserve will announce its July interest rate decision on July 29, Eastern Time. The current target range for the federal funds rate remains at 3.5%-3.75%, but the suspense surrounding this meeting is at a level rarely seen since September 2024. Data from the interest rate swaps market shows an approximate 40% probability of a 25-basis-point rate hike, while the CME FedWatch tool indicates a rate hike probability of about 36%, compared to just around 10% two weeks ago.

According to Bloomberg, Frank Flight, head of macro strategy at Citadel Securities, stated in a research report that the Fed could surprise the market with a 25-basis-point rate hike this week. He wrote that such a move would solidify Chairman Kevin Warsh's policy credibility in fighting inflation and "decisively end the era of forward guidance."

Frank Flight believes that a rate hike this week would have a greater impact than waiting until September, as it would fundamentally reshape market expectations of how the Fed responds to inflation. He also noted that a surprise hike would not only help cement the central bank's credibility but also trigger a ripple effect in corporate pricing and wage growth, thereby reducing the amount of tightening needed in the future.

A key driver of rising rate hike expectations comes from the energy market. Tensions in the Middle East escalated again this month, with Brent crude briefly breaking above $100 per barrel and posting a monthly gain of over 20%. Although oil prices pulled back after the U.S. suspended airstrikes on Iran on Monday, the risk of Houthi rebels threatening Red Sea exports has not been resolved. Frank Flight noted that upward pressure on energy prices in recent weeks could be a key variable driving a rate hike.

[Source: TradingView]

However, this hawkish expectation does not align with the views of most economists. All 104 economists surveyed by Reuters in mid-July expect interest rates to remain unchanged this week, with 78 of them believing that this rate level will be maintained until December this year.

[Source: Reuters]

Goldman Sachs ( GS) chief U.S. economist David Mericle believes that following the softer June inflation data, most voting members are unlikely to push for a rate hike this week, but at least one member is expected to cast a dissenting vote in favor of a hike.

Neil Dutta, chief economist at Renaissance Macro Research, believes: "Rather than waiting until September when there's no other choice, it is better to raise rates early now, allowing Warsh to retain flexibility in future policy decisions."

Meanwhile, traders have fully priced in the expectation of one Fed rate hike by September. Whether the Fed will hold rates steady or surprise with a hike in July will soon be revealed.