Is the Fed's Hawkish Shift Underestimated? Citadel Bets on a Surprise Rate Hike This Week to Strengthen Anti-Inflation Credibility and Break the Shackles of Forward Guidance

According to Zhihui Finance APP, the Federal Reserve will hold its policy meeting from July 28 to 29 local time (this Tuesday and Wednesday) and announce its interest rate decision on Wednesday. The market generally expects the Federal Reserve to maintain the benchmark interest rate unchanged. According to the CME FedWatch tool, there is a 63.7% probability that the Fed will keep rates unchanged in July, and a 36.3% probability of a 25 basis point rate hike.

However, Castle Securities expects the Federal Reserve to raise interest rates this week—an unexpected move that would enhance Fed Chairman Kevin Walsh's credibility in dealing with inflation. Frank Freight, head of macro strategy at the company, said in a report that raising rates by 25 basis points on Wednesday would reinforce Walsh’s repeated commitment to restoring price stability, as well as signal that policymakers are no longer relying on preemptively providing the market with explicit signals for every policy action.

Freight stated, “The market may once again be underestimating the extent of the Fed’s hawkish policy stance.” A rate hike this week “would clearly mark the end of the forward guidance era,” and would further underscore the Fed’s independence.

As the Federal Reserve’s policy meeting approaches, there is still considerable disagreement in the market over whether the Fed will hike rates this month. Looking at market expectations ahead of Fed decisions in recent years, such a high level of uncertainty is unusual so close to a policy meeting. Since taking office as Fed Chair in May of this year, Walsh has repeatedly stated his desire to do away with the Fed’s longstanding practice of signaling rate paths through forward guidance. He believes that releasing policy signals in advance could limit the flexibility of decision-makers amid rapidly changing economic conditions.

Although it remains uncertain whether the rate hike will occur this week, traders have fully priced in the expectation that the Federal Reserve will raise rates in September. However, in Freight’s view, acting this week would have a greater impact compared to waiting until September, as it would change the market’s expectations regarding how the Fed responds to inflation.

Freight noted that in addition to strengthening the Fed’s credibility in fighting inflation, a surprise rate hike would also affect corporate pricing decisions and workers’ wage demands, thereby having an effect before inflation becomes further entrenched and potentially reducing the need for future tightening.

Despite recent weaker employment and inflation data briefly reducing market expectations for a July rate hike, Freight believes these figures should not outweigh broader evidence—that inflation risks remain elevated and the labor market is still stable.

Meanwhile, geopolitical tensions in the Middle East remain highly unstable. International oil prices fell on Monday after the US suspended its daily strikes against Iran. However, despite some easing of recent tensions, oil prices have risen about 20% so far this month—the result of threats from Iran-backed Houthi forces to Saudi oil shipments through the Red Sea. Freight added that rising energy prices in recent weeks could become a key factor prompting a Fed rate hike.