A Fed Rate Hike This Week?

The stock market could be surprised by a Fed rate hike at this week's FOMC Meeting, as a case can be made for the Fed to act now.  To be sure, arguments for the Fed to wait also can be made.  So, it's far from a slam dunk.  And, if it does hike, a consequential stock market hit conceivably could be quickly reversed.  The market also will have to contend with Iran war developments and tech consolidation.  Strong corporate earnings should be in the background, as well.

Market expectations lean toward a Fed rate hike at September's FOMC Meeting, but a case can be made for the Fed to act now.  /1/ The latest rebound in oil prices underscores the inflation problem.  Besides its direct and indirect boosts to inflation data, it could lift inflation expectations -- that could feed into wage negotiations and thus a wage-price spiral.  /2/ The rise in longer-term yields reflects market fears that inflation will climb.  The higher yields send a troubling signal from the markets to the Fed that inflation expectations are moving up.  /3/ The real economy is doing fine and even may be accelerating.  It should not stand in the way of a hike.  /4/ A quick response by the Fed would demonstrate its seriousness in fighting inflation.  After Fed Chair Warsh's insistence that the Fed will nip inflation, a quick move would show his words are not an empty promise.  /5/ Congress gave approval to go against inflation at his recent Semi-Annual Monetary Policy testimony.  /6/ A rate hike in July hike would be further ahead of mid-term elections than in September, making the tightening less of a political issue in the fall.  /7/ The reasons for the 2024-25 rate cuts no longer apply -- /a/ real rates are not higher because inflation fell and /2/ the labor market is not weakening, unlike what appeared to be the case then.

Arguing against a July hike is the flat June Core CPI, which supports the Fed's expectation that the recent increase in inflation will be temporary.  This week's release of the June PCE Deflator should show a soft Core, as well.  Consensus looks for +0.1% m/m.  Also, the Fed's practice has been to set the stage for a hike before actually raising rates at the subsequent meeting.   However, Warsh may drop this practice, which would be in line with his intent to change Fed communication methods and with his view that the Fed should not tell markets.of the Fed's policy projections.  

The real economy is not standing in the way of a Fed rate hike.  Growth is being propelled by increased defense spending and AI investments.  Consumption growth remains on trend.  This week's advance report on Q226 Real GDP is expected to indicate decent growth.  Consensus looks for 2.3% (q/q, saar) Real GDP Growth, a bit higher than the 2.1% in Q126 and above the Atlanta Fed model estimate of 1.7%.  The consensus estimate is at the high end of the Fed's 2.0-2.3% Central Tendency Projection for 2026 as well as being above the Fed's 1.8-2.0% estimate of longer-run growth.  

And, the Unemployment Claims data show the labor market improving and possibly at a fast clip.  Both Initial and Continuing fell further in the latest week, with Initial making a new low for the year.  They indicate that layoffs have fallen and that hiring may have picked up.  The data point to a speedup in July Nonfarm Payrolls, due August 7.  

This week's Labor Cost data, nevertheless, are expected to be benign.  Consensus looks for the Q226 Employment Cost Index to rise 0.8% (q/q), versus 0.9% in Q126.  A slowdown would be consistent with Average Hourly Earnings. 

Ironically, the stock market may recover quickly after a Fed rate hike this week.  This could be the case if, as is likely, the hike pushes down commodity prices and, as a result, the 10-year Treasury yield, as it undermines the more extreme expectations of higher inflation ahead.  The reduction in the drag on the consumer from higher oil prices and the boost from lower long-term yields would be stock market positives.