The Game between the Federal Reserve and the Market: Will There Be Another Rate Hike after July?

The trend of a rate hike in the United States in July has been determined. Will this be the last rate hike?

Data released last week showed a significant cooling of inflation in the United States, with the year-on-year increase in CPI in June falling from 4% in May to 3%, lower than the expected 3.1%. This marks the 12th consecutive month of decline and the lowest level since March 2021, far below the 9.1% of a year ago.

This has sparked hope among investors, and the logic of a "soft landing" has swept the entire market. The optimistic sentiment in the market seems to be driving everything up. The S&P 500 and Nasdaq both achieved the largest weekly gains in one and three months respectively last week, while the Dow Jones Industrial Average rose for five consecutive days.

However, Federal Reserve officials remain firm in their views that the fight against inflation is far from over, and they maintain an open attitude towards further rate hikes later this year. This is especially true considering that they were previously misled by the slowdown in price pressures, only to see them rise again.

Market Cheers

Investors have increased their bets on a "soft landing," believing that the 25 basis point rate hike at the July 25-26 Federal Reserve meeting will be the last rate hike in this tightening cycle.

US stocks and bond prices have risen in the past week due to market expectations. The market barometer of the Federal Reserve's intentions, the yield on two-year US Treasury bonds, fell from 4.95% on July 7 to 4.76%.

This has ignited people's hopes that the Federal Reserve can achieve the so-called "soft landing" of the economy, that is, reducing inflation without causing a recession in the United States.

Mohamed El-Erian, Chief Economic Advisor at Allianz Group, bluntly stated that since the market generally believes that the US economy can achieve a "soft landing," there is no need to oppose this view.

Fed's Caution

However, no matter how reassuring the data may be, several Federal Reserve officials remain cautious.

Mary Daly, President of the Federal Reserve Bank of San Francisco, said in an interview with CNBC on July 13:

It is too early to say that we have won the battle on inflation. One data point does not make a trend.

On the same day, Federal Reserve Board Governor Christopher Waller told currency market participants at New York University:

Inflation briefly slowed down in the summer of 2021, but then the situation worsened. Therefore, I need to see this improvement continue to be convinced that inflation has slowed down.

Loretta Mester, President of the Federal Reserve Bank of Cleveland, stated in a speech on July 10:

We are nearing the end of the tightening phase. Nevertheless, the economy has shown stronger underlying strength than expected earlier this year, and the inflation rate remains stubbornly high. The federal funds rate needs to be further raised from its current level.

Currently, after raising interest rates 10 times in a row to a range of 5% to 5.25%, the Federal Reserve kept rates unchanged in June. According to the forecasts released after the June meeting, most policymakers at the time expected two more rate hikes by the end of this year, each by 25 basis points. Federal Reserve officials have expressed their willingness to push for another rate hike, and what surprised policymakers is not only the persistence of inflation, but also the resilience of the labor market. Powell has repeatedly stated that in order to bring the inflation rate back to the Fed's target of 2%, the labor market may need to slow down.

There are signs that this is happening. Nonfarm payroll growth slowed to 209,000 last month, the smallest increase since the end of 2020, but still more than twice the roughly 100,000 pace that Powell described as the ideal long-term economic growth.