Castle Securities: Powell May Surprise with Rate Hike This Week

July 28th, Citadel Securities' Head of Macro Strategy, Frank Fliat, expects the Federal Reserve to surprise the market with a 25 basis point rate hike this Wednesday. He believes that this move will reinforce Chair Powell's commitment to price stability and highlight the central bank's independence in monetary policy decisions.

Frank Fliat stated that the market may once again underestimate the Fed's hawkish turn. The rate hike this week would actually mark the end of the "forward guidance era," where the Fed no longer telegraphs policy decisions in advance. The current probability in the interest rate swap market for a 25 basis point hike at this meeting is around 40%, but it has almost entirely priced in one hike before September.

Citadel Securities believes that the market impact of an early rate hike this week will be greater than waiting until September to act. An earlier policy tightening could alter market expectations for how the Fed will address inflation and impact corporate pricing and employee wage demands, thereby reducing the eventual need for additional tightening.

Despite recent softness in employment and inflation data, Frank Fliat still sees inflation risks as elevated and the labor market remaining tight. Escalation in the Middle East has driven energy prices higher, increasing the likelihood of a rate hike; although oil prices retreated after the U.S. paused daily airstrikes on Iran, crude oil is still up approximately 20% for the month.