The probability of the Federal Reserve raising interest rates by a quarter point in July has notably increased, with CME's FedWatch tool indicating a 46.5% chance, up from 34% on Sunday, and Kalshi showing a 36% chance, up from under 20%. This surge in expectations is largely attributed to recent geopolitical developments, specifically President Donald Trump's reinstatement of the U.S. blockade of Iranian ports and a 20% toll on cargo through the Strait of Hormuz, which caused U.S. oil prices to jump over 5% to above $75 per barrel.
Further contributing to the hawkish sentiment are statements from Federal Reserve Governor Christopher Waller, who emphasized the importance of not repeating past mistakes of delaying rate hikes amid rising inflation. These comments, combined with the oil price shock, have led bond traders to significantly increase their bets on a July rate hike, with money-market pricing on Monday reflecting a nearly 50% possibility, up from less than 40% earlier in the session. Two-year Treasury yields, sensitive to Fed policy changes, rose to $4.28, the highest since February 2025, and the 10-year yield reached $4.62, the highest since May.
The upcoming release of June consumer price figures from the Bureau of Labor Statistics on Tuesday, followed by producer price data on Wednesday, are highly anticipated and are expected to be key in shaping the Fed's decision. Economists surveyed by Dow Jones project June inflation to have risen 3.8% annually, a decrease from May's 4.2%. Additionally, Fed Chairman Kevin Warsh is scheduled to make his first congressional appearance, testifying before the House Financial Services Committee on Tuesday and a Senate committee on Wednesday, where he will discuss the new inflation data with lawmakers. His testimony is expected to significantly influence market probabilities for a July rate hike.
Analysts like Ajay Rajadhyaksha from Barclays suggest that the pass-through effects of higher oil prices are still ongoing, and sustained elevated energy prices, coupled with AI-induced price hikes, are deteriorating the overall inflation outlook. He warns that a data-dependent Fed will likely have to respond to inflation prints that are not expected to look favorable in the coming months, indicating a potential need for a more hawkish stance to address broader price pressures beyond just energy. Despite rising odds for a hike, many investors' base case remains for no monetary tightening this year.
The Federal Reserve is set to announce its next interest rate decision on July 29.
