- We expect the Federal Reserve to remain on hold in the July meeting, in line with consensus. Markets price in 20-25% probability for a hike.
- Without new projections or forward guidance from Warsh, the focus will be on the vote split. We think the most likely outcome is 2-4 votes in favour of a hike.
- We forecast 25bp hikes in December and March, with risks skewed towards an earlier start. We recommend remaining short EUR/USD spot going into next week’s meeting.
The first month after Kevin Warsh’s debut at the FOMC’s June meeting has brought mixed signals on the inflation front. On one hand, the re-escalation of the war in Iran has lifted energy prices higher again. Yet on the other hand, Warsh’s hawkish comments have already lifted real rates, supported broad USD and tightened financial conditions while realized inflation surprised to the downside in June.
Assuming Warsh sticks with only limited forward guidance, the meeting could leave markets with little to digest aside from the rate decision itself. In the June ‘dots’, 6 participants saw at least two hikes this year. We see a chance for 2-4 votes in favour of a hike already in July. Aside from Warsh, regional Fed hawks Logan, Hammack and Kashkari have appeared open to tightening policy at a relatively early stage. Governor Waller warned before the June CPI release that if core inflation was ‘hot’, FOMC would need to consider tightening policy in the near-term. However, we think that the broadly lower-than-expected reading eased the need for rapid tightening.
Looking further ahead, we assess that Bowman, Jefferson and Cook could eventually tilt the balance towards hiking in the later meetings. Williams, Daly, Paulson and Barr have not signalled an imminent bias towards hiking, while Powell has (intentionally) remained on the backlines when it comes to communication.
Back in May, we laid out the three main arguments for tightening policy: the AI-capex boom, more supportive fiscal impulse and re-tightening labour market balance. We still think these will justify hiking rates twice, in December and March, but elevated energy prices skew the balance of risks towards an earlier start. Markets price in 5-6bp worth of hike probability for next week, 36bp by year-end and 47bp by March.
Last week, we recommended a tactical short EUR/USD spot position ahead of the July rate decision(s). We see an asymmetric outcome space around the meeting, where a unanimous hold would not materially affect hike expectations in later meetings, but a surprise hike or a close-call split decision could drive a hawkish repricing of USD real rates and support broad USD FX.
Finally, we do not expect any changes to the Fed’s balance sheet policies, as the task force announced in July will continue its work towards year-end. For now, NY Fed continues to expand the Fed’s T-bill holdings with net reserve management purchases a USD10bn per month, as has been the case since mid-May.
