Will the Federal Reserve raise interest rates by 25 basis points in July, and will it be the last time in this round?

According to Zhongtong Finance APP, various signs indicate that the Federal Reserve policymakers seem to be ready to resume raising interest rates this month and remain open to further rate hikes later in the year.

Although officials are encouraged by the decline in inflation pressures last month, they do not appear inclined to declare that the fight against inflation has ended, as the persistence of inflation has repeatedly caught them by surprise. One factor that keeps them cautious is their strong desire to avoid repeating the mistakes of the 1970s when the Federal Reserve prematurely relaxed its efforts to contain inflation, leading to a subsequent acceleration of inflation to double-digit levels.

San Francisco Fed President Daly said in an interview on July 13th, "It is too early to say that we have declared victory over inflation."

At present, investors have increased their bets on a 25 basis point rate hike at the Federal Reserve's July 25-26 meeting, believing that this will be the last rate hike in this tightening cycle.

Driven by these expectations, stock and bond prices have risen in the past week, and the market barometer of the Federal Reserve's intentions, the two-year US Treasury yield, has fallen from 4.95% on July 7th to 4.76%.

The main factor driving the rise in stocks and bonds is the sharp decline in inflation last month. The US Department of Labor reported on July 12th that the Consumer Price Index (CPI) in June rose 3% compared to the same period last year, lower than the 4% in May. This is the smallest increase in over 24 months, far below the 9.1% increase a year ago.

This in turn has fueled hopes in the market that the Federal Reserve will be able to achieve the so-called "soft landing" of the economy, reducing inflation without causing a recession in the United States.

Mohamed El Erian, Chief Economic Advisor at Allianz Group, said, "You can't deny the idea of a soft landing now - it's gaining momentum."

Cautiously Optimistic

However, for Federal Reserve officials, they remain cautious about reading too much into any one month's data, no matter how reassuring that data may be. This is especially true considering that they were previously "deceived" by the easing of inflation pressures, only to see price pressures rise again.

On July 13th, Federal Reserve Board member Waller said, "This is good news, but one data point does not represent a trend. Inflation briefly slowed down in the summer of 2021 and then got worse, so I need to see this improvement continue before I can be confident that inflation has slowed down. "After raising interest rates to a range of 5% to 5.25% in 10 consecutive meetings, the Federal Reserve paused its rate hikes for the first time in June this year. According to the forecasts released after the June meeting, most policymakers expected two more rate hikes by the end of this year, each by 25 basis points.

Furthermore, several officials reiterated this view before the start of this month's meeting, emphasizing that the final outcome would depend on the development of the economy.

"I see no reason not to have the first of these two rate hikes at the later meeting this month," Powell said, "and then I need to see how the data evolves."

Policymakers generally expressed a greater willingness to push for another rate hike now, as concerns about credit tightening have not materialized. However, some, including Fed Chair Powell, warned that it is still too early to completely lift the alarm after the banking turmoil earlier this year.

Anna Wong and Stuart Paul of Bloomberg Economics said, "The Fed is almost certain to raise rates by 25 basis points in July, but a favorable CPI report will support the FOMC's view that the July rate hike should be the last - which is in line with our baseline expectations."

Job market still needs to slow down

Surprising policymakers is not just the persistent inflation. Faced with the Fed's most aggressive tightening policy in decades, the US economy, especially the labor market, has also shown some resilience.

Powell has repeatedly stated that some weakness in the labor market may be needed to bring the inflation rate back to the Fed's 2% target.

And there are signs that this is happening. Last month, job growth slowed to 209,000, the smallest increase since the end of 2020, but still more than twice the roughly 100,000 people that Powell suggested would be favorable for long-term economic growth.

Wage growth has also slowed, but remains above the level that Fed officials believe is consistent with the 2% inflation target. Average hourly earnings in June increased by 4.4% compared to the same period last year, lower than the peak of 8.1% shortly after the outbreak of the pandemic in April 2020, but higher than the average level of 3.3% in 2019.

This has led Powell and other policymakers to judge that the Fed is at greater risk of not doing enough to control inflation than of doing too much and triggering a deep recession - although they also said that these risks are now more balanced after multiple rate hikes.

"We are now closer to the end of the tightening phase than we were at the beginning," Cleveland Fed President Mester said in a speech on July 10. "That being said, the economy has shown more potential strength than expected earlier this year, and inflation remains elevated."

Therefore, "the federal funds rate needs to be further raised from its current level," she concluded."