Traders head into Wednesday’s Federal Reserve decision pricing 36% odds of a quarter-point rate hike, far less certainty than a meeting week usually brings. Most economists expect no move, but Chairman Kevin Warsh has ended forward guidance and Deutsche Bank sees real risk of tightening. The S&P 500 would likely fall in the immediate aftermath of a surprise.
New Federal Reserve Chairman Kevin Warsh doesn’t want monetary policy to be predictable, and he has broken from the Fed’s longstanding practice of telegraphing upcoming moves. Seema Shah, chief global strategist at Principal Asset Management, wrote that investors are approaching the July FOMC meeting with lower conviction than is typical. Most economists expect the Federal Open Market Committee to hold its key rate steady, yet Deutsche Bank’s economics team wrote in a Monday note that “there is a significant risk of a 25bp (basis point) hike”.
Markets price 36% odds of a July move
Before Warsh, Wall Street was typically near certain about FOMC outcomes, with markets pricing around 90% or higher odds of the expected result. Going into this week’s meeting, markets see 64% odds of no move and 36% odds of a quarter-point tightening.
Further out, markets price 80% odds of at least one rate hike by the end of the Sept. 16 FOMC meeting, including 25% odds of 50 basis points in hikes. By the end of 2026, those odds climb to 91.5% for at least one hike and 59% for more than one. The committee is expected to leave rates unchanged at 3.75%, with markets instead pricing a 56% chance of a September rate hike, according to CME Group’s FedWatch tool.
One hike or the first of several
Markets will need to adjust to tighter policy if the Fed surprises, and the S&P 500 would likely fall in the immediate aftermath. The key will be whether investors view a hike as a one-time precautionary move that buys the Warsh Fed credibility as an inflation tamer, or as the first of multiple hikes.
Shah pointed to the historical record, writing that stocks have struggled when inflation-driven tightening cycles resume. Strong corporate profitability suggests a single hike would be more likely to moderate returns than derail the bull market, she added, while a series of hikes would pose a more significant challenge, particularly given elevated valuations for the index.
Should the Fed stand pat, markets won’t enjoy a relief rally unless the interest-rate outlook shifts in a more dovish direction. A key signal may be how many policymakers dissent from a decision to leave rates unchanged, and Deutsche Bank expects at least two dissents and possibly three.
Treasury yields ease before the call
Bond desks trimmed positions ahead of the decision. The 10-year Treasury yield fell more than 1 basis point to 4.628%, the main benchmark for mortgages, auto loans and credit card debt. The rate-sensitive two-year yield edged lower to 4.30%.
Rate futures reflect a roughly 38% probability of a quarter-point hike, up from 16%. Fresh import tariffs, a recent surge in crude oil and resilient economic activity have fueled growing speculation over whether Warsh could deliver a hawkish surprise.
What the June minutes signal
Warsh declared an end to forward guidance on June 17, but the minutes of that meeting spelled out how the Fed might react across scenarios. Most participants remarked that growth exceeding potential output, owing in part to strong AI business investment, could contribute to more persistent inflationary pressures.
If labor market conditions remain stable, the minutes said inflation could stay elevated because of strong AI-related demand, the conflict in the Middle East, or the effects of tariffs, and almost all of those participants indicated some policy firming would likely be warranted to return inflation to 2 percent. The near-term risk for the S&P 500 grows if the Fed has to contain more than one of those three concerns.
Sources: Investor’s Business Daily, CNBC, Investing.com
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