Citi expects the Federal Reserve to leave interest rates unchanged at its July meeting despite rising oil prices, and reads that outcome as dovish for Treasury yields and the U.S. dollar. Markets have priced in roughly a 30% probability of a rate increase. The bank also expects multiple dissents from policymakers favoring higher rates.
The Federal Reserve is likely to leave interest rates unchanged at its July policy meeting despite rising oil prices, according to Citi, which argues that markets are overstating the chances of an immediate rate hike as recent inflation and labor market data point to easing price pressures.
Markets are divided ahead of Wednesday's Federal Reserve decision as higher oil prices have fueled speculation of a hike, with traders pricing in roughly a 30% probability of a rate increase. Citi expects the Fed to keep rates steady, arguing that softer-than-expected June core inflation and slowing payroll growth make it difficult to justify tightening after officials opted not to raise rates in June.
A hold would read as dovish for the dollar
Leaving rates unchanged would likely be viewed as a dovish outcome that pushes Treasury yields and the U.S. dollar lower, Citi said. The bank expects the majority of policymakers to conclude the economy is not overheating, citing moderating job growth, a sharp drop in labor force participation, and June core CPI data consistent with pre-pandemic inflation trends.
Yet Citi also expects multiple dissents from policymakers favoring higher rates, with Cleveland Fed President Beth Hammack and Dallas Fed President Lorie Logan likely to vote for a hike. More than two dissenting votes would be interpreted as a stronger hawkish signal, the bank said.
Warsh seen avoiding both a surprise and guidance
Some investors expect Chair Kevin Warsh to answer higher oil prices with a surprise rate increase to reinforce the Fed's inflation-fighting credibility. Citi argues such a move would be inconsistent with falling market-based inflation expectations and with Warsh's previous comments suggesting supply-driven price shocks should not automatically trigger tighter monetary policy.
The bank also expects Warsh to avoid forward guidance at his post-meeting press conference, keeping his preference for offering little indication of the Fed's future policy path. Citi said any repetition of his recent remarks downplaying AI-driven inflation or emphasizing different measures of inflation could be interpreted as marginally dovish.
Beyond July, Citi expects another few months of softer labor market data and subdued inflation to eliminate expectations for further rate hikes and open the way for the Fed to resume rate cuts as early as October.
Source: Investing.com
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