The "Most Uncertain" Decision in Years! Will Tonight's Fed Meeting Deliver a "Shock"?

Tonight's Federal Reserve decision is highly likely to remain a "hold," but what the market truly fears is not the baseline scenario, but rather a rare surprise rate hike or a pause accompanied by sufficiently hawkish language.

At 2:00 AM Beijing time on July 30, the Federal Reserve will announce its latest interest rate decision. This meeting will not include updates to the dot plot or economic projections, and the target range for the federal funds rate is expected to remain at 3.50%-3.75%. According to a Reuters survey, all 104 respondents expect rates to remain unchanged. However, money markets are still pricing in approximately a 32% probability of a rate hike this week and about 42 basis points of tightening for the year, making tonight's meeting the one with the strongest "uncertainty" in recent years.

Uncertainty stems from the tug-of-war between two forces. June's CPI came in broadly below expectations, non-farm payrolls were weaker than anticipated, and oil prices retreated before the meeting, all providing the Fed with room to continue waiting. However, inflation remains above target, geopolitical tensions in the Middle East and fluctuating oil prices persist, some Fed officials have recently struck hawkish tones, and Waller has yet to establish a clear policy track record, making it difficult for the market to completely rule out the risk of a rate hike.

Jonathan Pingle, Chief US Economist at UBS, stated that the level of uncertainty he feels regarding the upcoming Fed decision is the highest in 20 years—the last time he had similar feelings was when Bernanke first took over as Fed Chair. "Waller will dominate the policy direction in the coming meetings, and we know almost nothing about how he views monetary policy."

For investors, risks are concentrated in short-term interest rates, with immediate reactions expected in the US dollar and US equities. According to JPMorgan Market Intel calculations, if the Fed unexpectedly hikes rates by 25 basis points, the S&P 500 could fall by 1.5%-2%; if it hikes by 50 basis points, the decline could widen to 2%-4%. Even if rates remain unchanged, as long as the statement and press conference are hawkish, it could limit the rebound in risk assets.

Market Consensus is a Pause, but Pricing is Not Calm

From a traditional forecasting perspective, this decision seems to have no suspense. According to a Reuters survey, all 104 economists expect the Fed to keep rates unchanged. Of these, 78 expect no rate adjustments for the remainder of the year, with only six expecting a rate cut.

However, the same survey showed that 66% of respondents believe the likelihood of a rate hike this year is "high," a significant shift from the prevailing "low" judgment in June. Market pricing also indicates that investors are paying for the tail risk of a rate hike. Traders are currently not only assigning about a 30% probability to a hike this week but are also fully pricing in a 25-basis-point hike before September and nearly 50 basis points of hiking before next March.

Goldman Sachs believes this pricing implies that the outcome of this meeting is "exceptionally uncertain." If the Fed hikes rates, it would be a historically rare surprise move; if it does not hike, the market will quickly reassess the previously priced-in hike risk. Ian Lyngen of BMO Capital Markets noted that since 2015, the average error by traders in predicting the final rate decision on the day before the Fed announcement was only 2.4 basis points, but this time the market is more prone to a sharper immediate reaction than usual.

Data Supports Waiting, but Inflation Risks Remain

The rationale supporting a Fed pause mainly comes from the latest data. June's CPI was lower than expected, weakening the bets on a rate hike triggered by Waller's earlier hawkish comments. Waller had stated that if June's core CPI had been hot, a recent rate hike should be considered; if the data were cool, he would need to see more similar readings before viewing them as a clear signal.

The labor market has also given the Fed more time to observe. June's non-farm payrolls were weaker than expected, with previous values revised downward. The net revision for the two months was a decrease of 74,000 jobs, compared to a previous increase of 93,000. Although the unemployment rate declined slightly, materials indicate this may be primarily due to a drop in the overall labor force participation rate.

Oil prices are also a key variable. Conflicts between the US and Iran escalated after the last meeting, with relevant memorandums of understanding violated and both sides resuming strikes. However, over the weekend before the meeting, strikes paused, geopolitical risk premiums decreased, and oil prices fell accordingly, helping to ease inflation expectations. Fed officials have previously warned against responding too quickly to supply shocks that may be only temporary.

The issue is that underlying inflation remains significantly above target. Morgan Stanley points out that upside risks include persistently high oil prices, a more hawkish Fed reaction function, and AI-driven investment pushing up the neutral interest rate. Goldman Sachs also believes that while the combined impact of tariffs, war, and AI statistical errors on monthly inflation may weaken in the future, uncertainty remains high. Once the improvement in inflation stalls, discussions within the Fed about raising rates will heat up again.

Communication in the Waller Era is Itself a Risk

The last FOMC meeting chaired by Waller was also his first. At that time, the statement was significantly shortened, forward guidance language was removed, and the committee's commitment to bringing inflation back to the 2% target was reinforced. This means that even slight changes in wording this time will be amplified and interpreted by the market.

Morgan Stanley expects the statement this time to likely remain unchanged, including reiterating the "ample reserves" policy, describing economic activity as expanding at a "robust pace" amid high uncertainty, the unemployment rate as "little changed," and inflation as still "elevated." Since there is no Summary of Economic Projections this month, policymakers have no need to reset market expectations through the dot plot.

The press conference may be more important. Waller is expected to be asked about the impact of the Middle East conflict on inflation, the newly announced chair's working groups, and whether the latest data will accelerate the policy action timeline. Goldman Sachs expects Waller not to give clear policy signals, possibly emphasizing that all options remain open and future decisions will depend on data.

Credit Agricole believes the Fed is entering a new phase with more limited forward guidance, which will turn more meetings into true "live meetings." The bank expects the Fed to hold rates steady this time, believing that data since the last meeting has at least bought time for a continued pause. Regarding the five new working groups established by Waller, Credit Agricole does not expect significant updates in the near term, with related recommendations likely to be completed closer to the end of the year, implying that balance sheet policy is unlikely to change temporarily.

Widening Divisions, A Pause May Also Come with Dissent, Watch for Opposing Votes

Internal divisions within the Fed are the core of the uncertainty surrounding this meeting. In the June projections, 9 out of the 18 participants who submitted forecasts expected at least one rate hike this year. Since then, statements from several officials have shown that they are willing to consider further tightening if the disinflation process stalls.

Both Waller and Cook have stated that they might consider tightening policy if the anti-inflation progress stalls. The remarks of 2026 voting members Logan and Hammack were even more hawkish. Logan argued that the policy rate should be moderately higher to better balance prospects and risks, and believed that some restrictive policy is still needed to help inflation return to target. Hammack directly stated that the Fed might need to consider raising rates.

Therefore, even if rates remain unchanged, there may be dissenting votes. Based solely on recent comments, if the Fed chooses to pause, there could be 2 to 4 dissenting votes in favor of a rate hike. Goldman Sachs expects that this statement may acknowledge the upside inflation risks brought by geopolitical conflicts and that at least one member may vote in favor of a rate hike.

Bank of America analyst Mark Cabana expects the Fed to keep rates unchanged on Wednesday but may attract opposition from regional Fed presidents Lorie Logan and Beth Hammack. He also stated that if the market does not rule out the risk of a rate hike, strategists will not rule it out either.

A Few Institutions Bet on a Rate Hike "Shock"

Although the mainstream view remains a pause, some institutions are explicitly betting on a surprise rate hike. Citadel Securities has become a notable outlier, with its Head of Macro Strategy, Frank Flight, changing the baseline scenario this week to a 25-basis-point hike this week. He believes this would strengthen Waller's credibility in fighting inflation and "clearly end the era of forward guidance."

Robert Tipp, Global Head of Fixed Income and Chief Investment Strategist at PGIM, also stated that the market may be underestimating the probability of action on Wednesday. He believes that Waller has actually set the stage for a rate hike, and if the decision is postponed now, it could increase the probability of a 50-basis-point hike in September.

Lou Crandall, Chief Economist at Wrightson ICAP, stated that the Fed has no sufficient reason not to raise rates. Bond market veteran Harley Bassman even argues that the Fed should hike rates by 50 basis points at once to strengthen its anti-inflation credibility.

However, Goldman Sachs still believes that most voting members are unlikely to push for a rate hike this week after June's softer inflation data. The bank also pointed out that the Fed has historically avoided creating surprise rate hikes at meetings, especially at meetings without a Summary of Economic Projections, where officials may be more concerned about the market over-interpreting their intentions.

Asset Reaction: A Hike is the Biggest Shock, A Hawkish Pause is Also Not Easy

JPMorgan Market Intel lists a "hawkish pause" as the baseline scenario, with a probability of 50%. In this scenario, the S&P 500 could rise by 0.25% or fall by 0.50%. The logic is that the Fed will pause due to the resilience of the labor market and growth, but will continue to emphasize vigilance against inflation.

If there is a surprise 25-basis-point hike, JPMorgan expects the S&P 500 to fall by 1.5%-2%, with the Nasdaq 100 potentially falling even more. If it hikes by 50 basis points, the S&P 500 could fall by 2%-4%. If it is a "dovish pause," meaning rates remain unchanged and communication is softened, the S&P 500 could rise by 0.50%-1%. In the options market, options expiring on July 29 price in about 0.8% volatility for the S&P 500, lower than the approximately 1.1% pricing for recent CPI events.

In terms of foreign exchange, Goldman Sachs' FX team believes that if the Fed pauses, the US dollar may experience tactical weakness, but as long as energy prices remain high, this weakness may be short-lived. In the medium term, if the Fed keeps rates unchanged for the rest of the year as the bank's economists expect, it will exert mild but manageable pressure on the US dollar against G10 currencies.

The focus in the interest rate market is on the front end. Goldman Sachs' rates trading desk believes the market may misinterpret the "lack of forward guidance" as deliberate ambiguity. The desk tends to believe that if the Fed Board does not support a rate hike, hawkish voters do not have enough votes to push for action this week. But if there is a pause in July, Waller may still deliver a hawkish pause and lay the groundwork for a September hike.

In commodities, Goldman Sachs' crude oil trading desk stated that the crude oil risk premium is rapidly dissipating, as the US and Iran formed a de facto ceasefire over the weekend and negotiations to reopen the Strait of Hormuz advanced. However, upside risks have not disappeared; if attacks on Saudi oil facilities or production continue, oil prices could rise again. Gold has fluctuated in a range of about $250 over the past two months; the trading desk maintains a long-term bullish view but prefers tactical trading around news events.

This means that the key tonight is not just whether rates change, but how Waller explains "no change" or "change." With the market already paying for hike risk and economists almost unanimously expecting a pause, whichever side the Fed chooses could bring a significant shock to the market.