Federal Reserve officials are all but guaranteed to leave the federal funds rate where it is at the central bank’s meeting next week, but the view will go into the second half of the year. In addition, there is a growing opinion among financial experts that the central bank’s next move would be to hike.
In a research note published last week, Goldman Sachs American economist David Mericle said that the prospect of an increase in price levels instead of a decrease is not as far off as it was last month. “The Fed’s comments have turned more hawkish in recent weeks, with many participants saying a hike is likely if inflation worsens,” he wrote. “We now place a higher probability of 20% (compared to 10% previously) on a small rate increase.”
This rapid change in expectations is enough to give investors whiplash.
“This year, people were expecting two cuts,” said Chris Zaccarelli, chief investment officer at Northlight Asset Management. But now, the Fed’s hands are effectively tied. “They don’t have the ability to reduce,” he noted, adding, “there are many people who are already talking about rising prices before the end of the year.”
According to CME FedWatch, which uses futures market activity to predict rate movements, the likelihood of the Fed hiking rates at its July meeting rose from 0% to 13% in the past month alone; which is expected to increase in September from 5% to 40%.
The swing in expectations gets bigger the further you look. Last month, there was more than a 75% chance that prices would remain flat or fall by the end of 2026. But as of Thursday, futures markets had returned that probability to less than 30%. In addition, markets are now predicting a more than 25% chance of a price increase of two percent or more before the year is out.
Zaccarelli believes it’s too early to think that a hike is inevitable, but he allows that it could happen if today’s economic conditions persist. “If the labor market continues to stagnate, there’s no reason why you should reduce the rates of inflation,” he noted, adding that inflation hawks “have a lot of power.”
“If inflation stays the way it is now, I think they will have no choice but to start raising prices,” he said.
Why policy makers are at odds
At the most recent meeting of the Federal Open Market Committee in April, officials voted to leave the fed funds rate unchanged in its current range of 3.5% to 3.75%. But underneath that event was an unprecedented disagreement, with some committee members favoring a reduction and others arguing that an expansion may soon be necessary.
Economists and analysts say that disagreements between policy makers are likely to continue. “We expect Federal Reserve policymakers to strongly emphasize that policy tightening is still possible if inflation shows more persistence than expected,” wrote EY-Parthenon Chief Economist Gregory Daco in a research note published Thursday.
Former Fed Chairman Jerome Powell – who chose to stay on the board as governor, in another unusual incident – was known in Washington and Wall Street to agree. It remains to be seen, however, whether new Fed Chairman Kevin Warsh will support a similar commitment to unity. An uncharacteristically sharp split among officials has been evident in recent months in policy statements and public statements by FOMC members.
Experts predict that opposing views will influence what could be seen as a political and economic situation. Some of this is a function of the political calendar, according to Skyler Weinand, chief investment officer at Regan Capital.
In a recent analysis, Weinard argued that these upcoming times could prevent officials from being seen to view monetary policy through a political lens — an allegation that President Donald Trump has repeatedly made while in office.
“It’s unlikely we’ll see a rate hike before the midterm elections, and any such hike is likely a year away,” Weinard predicted.
Even some analysts with a positive view of inflation agree that Wall Street may have to wait a while before seeing a rate cut.
“We don’t see any conditions where there is inflation sticking,” Jay Hatfield, CEO and chief investment officer of Infrastructure Capital Advisors, told Money via email.
But even if the Iran conflict is resolved and the Strait of Hormuz is reopened within the next two or three months, price cuts may still be the way out.
“We expect there will be significant delays in the post-Strait reopening,” Hatfield predicted. “They will have to see two to three months of inflation before cutting.”
