In a shift, traders are now betting the Federal Reserve’s next move will be a rate hike, even as new Chair Kevin Warsh and President Donald Trump have signaled support for lower borrowing costs.
The Fed typically lowers rates to stimulate the economy, which can incentivize hiring, and raises them to curb inflation. Today, forecasters’ rising expectations for a hike appear to be a reaction to continued traffic disruptions in the Strait of Hormuz that have pushed up the cost of oil, gas and related goods, as well as positive job growth in March and April.
While policymakers are somewhat divided on the best path for rates, they have yet to signal a hike is coming in the near future. Members of the rate-setting committee’s March 18 median projection for the federal funds rate, which serves as a benchmark for interest rates around the country, implied one quarter-point cut before the year’s end. Three members dissented from the April decision because they felt the committee’s accompanying statement was biased toward lowering rates in the future.
“The bar for a hike is quite high, not impossible, but it’s quite high,” Truist’s Head of U.S. Economics Mike Skordeles said. “We’ve got to see a lot of things break before a hike would realistically be the base case.”
Why Are Forecasters Predicting a Rate Hike?
While futures markets still largely expect policymakers will leave rates unchanged at their upcoming meetings, they now think the odds of a rate hike are higher than the odds of a cut, according to the CME Group’s FedWatch tool. As of the afternoon on May 18, it shows a roughly 49% probability of a hike in December and a 58% chance of a hike in January next year.
“All of this is recognition of the reality that any formal resolution to the conflict in the Middle East will take considerably longer than desired, and the inflationary impacts that were expected to be transitory will likely be far more persistent,” Jordan Rizzuto, chief investment officer at GammaRoad Capital Partners, said.
Some of that shift in expectations also appears to be driven by the global nature of futures markets, according to Skordeles. European investors, contending with surging natural gas and electricity costs, are likely contributing to the rise in rate hike expectations, he said, but added that those price pressures are not materializing in the United States the same way as they are in Europe.
For a rate hike to be a realistic expectation, Skordeles said, Fed policymakers would likely need to see softening retail sales and consumer spending, oil prices sustained at levels closer to those seen following Russia’s 2022 invasion of Ukraine, and the increased costs of oil leading to higher prices for more consumer goods. In other words, the Fed is still waiting on additional data before making its next move.
Will Warsh Try to Usher in Lower Rates?
The Federal Open Market Committee’s next meeting in June will mark Warsh’s first as chair. As Trump’s nominee, Warsh suggested looking through one-off price increases and said he believes AI-driven productivity gains could act as a disinflationary force.
“In theory, that framework leans dovish,” meaning he may favor lower rates, Christian Floro, a market strategist at Principal Asset Management, said in a note to USA TODAY. “In practice, sticky inflation alongside a strong economy may limit his ability to convince his fellow committee members.”
Even if Warsh sees lowering borrowing costs as the correct move, he’ll need to convince a majority of the FOMC to vote alongside him. The committee is made up of 12 voting members. Warsh has just one vote.
“There would be nothing in economic theory that would tell you this is a good time to cut interest rates,” said Jacob Robbins, an assistant professor of economics at the University of Illinois. “You should be very sure of how AI is going to affect the economy before you should call for lower interest rates at this moment.”
What Do Rate Moves Mean for Consumers?
In general, the Fed lowering its benchmark rate can lead to lower interest rates for consumers on things like credit cards, car loans and mortgages. A rate hike has the opposite effect, but benefits savers through higher returns on high-yield savings accounts and certificates of deposit.
“There’s often a reaction of, ‘Oh, well, rate hikes will be a net negative for consumers because it raises borrowing costs,’ and what we’ve seen is that raising the policy rate over time can certainly raise borrowing costs, but those effects are rarely immediate,” Rizzuto said.
In theory, higher borrowing costs are designed to curb inflation by making it harder to shop on credit or take out loans, but they don’t automatically make gas at the pump cheaper.
“Changing interest rates isn’t necessarily going to change whether the Strait of Hormuz is open or not,” Skordeles said.
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