Market watchers weigh chances of a surprise Fed rate hike tomorrow

Investing.com -- In just over 24 hours, Kevin Warsh’s Fed will announce its interest rate decision. While the consensus is for the Fed to remain on hold, a growing number of market watchers expect a surprise rate hike. Citadel Securities is one of those outliers, with the firm’s head of macro strategy Frank Flight expecting a 25-basis-point hike. Overall, 32% of market participants expect a hike tomorrow. This is down from yesterday, but up sharply from last week.

The rising probability of a hike, up from roughly 16% just a week ago, comes amid a June-to-July oil price surge that briefly pushed Brent crude above $100 per barrel amid renewed U.S.-Iran tensions. WTI crude is now trading at $79.31 as of Tuesday afternoon, down nearly 4% on the session, a retreat that could marginally soften the urgency for the Fed to act.

The backdrop for Warsh’s second meeting as chair is uniquely opaque. Unlike his predecessor Jerome Powell, Warsh has deliberately abandoned forward guidance, leaving markets without the signaling anchors they have grown accustomed to over the past decade. Inflation stood at 3.5% year-on-year in June, down from 4.2% in May but still well above the Fed’s 2% target, and the benchmark rate has been held in the 3.50%-3.75% range since December.

The hike camp draws its force partly from credibility arguments. Citadel Securities views a move as a way to strengthen Warsh’s inflation-fighting resolve. A hike, according to Flight, would "emphatically end the forward guidance era" and highlight the Fed’s independence.

Neil Dutta, chief economist at Renaissance Macro Research, made a similar case in a July 22 client note cited by Business Insider: "You must pick your spots against the consensus, and I feel like this might be one of those times. Most everyone else on the FOMC is on board for a hike in September. It might be much better to go now when you can and demonstrate some modicum of control over the policy decision than to go in September when you don’t have much choice."

UBS Global Research strategists said they "would not be surprised if they raised rates … to demonstrate their inflation-fighting resolve."

Wrightson ICAP analysts went further, telling Reuters the decision "could go either way" but that they believe the Fed is "more likely to raise rates by 25 basis points on Wednesday than to stand pat," adding that Warsh would face little widespread opposition if he pressed for tightening.

The hold camp has its own logic, and it centers on sequencing risk. Former St. Louis Fed President James Bullard put it plainly: "They don’t usually do a one-and-done, so it really means … the committee has to decide whether they’re going to commit to a sequence of rate increases. I don’t think they’re ready to do that at this meeting." In other words, once a tightening cycle begins, the Fed rarely stops at one move.

Bank of America’s Mark Cabana highlighted that according to federal funds futures data since 1994, the Fed has never hiked with less than 60% priced in beforehand. A hike would be "unprecedented," he said.

Equities are absorbing the uncertainty with relative composure. The S&P 500 is currently trading at 7,440.96, up 0.37% intraday, per Investing.com data, though rate-hike risk has visibly capped gains. The VIX is at 18.06, off 3.27% on the session but still well above its recent lows, consistent with the elevated macro uncertainty surrounding tomorrow’s decision.

Beyond the binary hold-or-hike outcome, the language of Wednesday’s FOMC statement will carry its own signal. Analysts are watching closely for whether the Fed retains or removes the phrase "attentive to inflation risks," which could indicate how September is being set up. Warsh’s press conference at 2:30 p.m. ET on Wednesday will be the primary market driver after the 2:00 p.m. ET decision, given his break from the guidance-heavy Powell approach.

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