Next week is the July 28–29 FOMC meeting, and the market is doing something it hasn’t done in a while, pricing in a real chance the Fed raises rates instead of cutting or holding.
Currently, the CME’s FedWatch tool puts the odds of a 25-basis-point hike at roughly 35%. While the odds are still low, the back and forth is what I am focusing on.
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In mid June, the U.S. and Iran reached a preliminary agreement to reopen the Strait of Hormuz for shipping and extend the ceasefire. Oil prices dropped on this news.
Because of this, the inflation data showed that inflation was starting to cool.
For example, if we strip out food and energy costs, the CPI (consumer price index) has dropped to 2.6% and is heading towards the Fed’s stated target rate of 2%:
The general consensus became that higher oil prices during the conflict were temporarily pushing the data higher:
So why are we even talking about raising rates right now?
Simply, energy and food.
Rising gas prices and food costs are impacting the consumer, which means they have less money to spend.
Since the US is a consumer-based economy, this means less profit for non-energy and non-food companies. Which can translate into layoffs and less jobs.
In addition, the closure of the Strait of Hormuz impacts the transportation of non-oil necessities like fertilizer.
And historically, when gas prices rise, so does the price of fertilizer, and therefore food costs rise:
But if the Fed tightens, this can also slow down the economy by raising borrowing costs and making expansion more difficult.
So the Fed, in my opinion, is stuck.
In fact, if we look at the expectation for future interest rate levels, we can see the Fed “flip-flopping” back and forth. (Yes, flip-flopping is my technical term for this):
The plots in the above chart show the Fed raising rates in 2026, then immediately dropping rates to a level lower than what they currently are.
As any long-time investor will tell you, the Fed has historically waited too long, and sometimes overreacts, on its moves. Most recently, calling inflation transitory in 2021 and 2022 and failing to take action.
My base case remains that the Fed should not raise rates, because they have proven in the past to not be nimble enough for the “flip-flop” scenario.
Especially if they think they can time geopolitical events, like the war in Iran.
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