Federal Reserve: Knife-edge policy risks surprise – ING

ING’s Padhraic Garvey expects the Federal Reserve (Fed) to leave rates unchanged at the upcoming Federal Open Market Committee (FOMC) meeting, with odds seen around 60:40 for no move. He argues that calmer June inflation, reduced geopolitical tensions with Iran and vulnerabilities in the US economy outside tech support a hold. However, he notes a non-negligible risk of a surprise 25bp hike.

Fed decision finely balanced at 60:40

"The upcoming FOMC meeting will be the first in quite some time that a large portion of observers will get an outcome they did not anticipate. It's practically on a knife-edge, at 60:40 in favour of no change. The logic for no change centres, in part, on the calming in June inflation readings."

"Our call is for no change. We see inflation expectations tame enough for comfort. Also, the structure of the curve does not shape up for a rate hiking cycle."

"Specifically, the 5yr is rich to the curve. It's unusual for the Fed to start a rate hiking cycle with the 5yr rich to the curve. If we're wrong and the Fed does hike (whether at this meeting or the next), the curve structure suggests that any hikes delivered will be subsequently reversed, and the funds rate ends up lower than it is today within a 12-month window."

"That said, the Federal Reserve could be forgiven for lobbing a protective hike in. It's what central banks tend to do when there is a perceptible rise in inflation over and above preferred ranges. The market has been paving a path towards a hike for this reason, as it's the logical market discount to have."

"One final point – if Warsh is minded to get a hike in (and maybe he is), better to do it at this meeting than to wait for it to be discounted by the market at the next one. The temptation to show some Fed independence vis-à-vis the market must absolutely be there. For clarity, we don't call for a hike."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)