Federal Reserve rate hike this week? Castle Securities: If Waller supports a rate hike this week, it will strengthen anti-inflation credibility and put an end to the era of forward guidance.

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Citadel Securities expects that the Federal Reserve will raise interest rates at this week's meeting—a surprising move that will enhance Fed Chair Kevin Walsh's credibility in fighting inflation.

Frank Flight, head of macro strategy at the firm, wrote in a report that if the Fed announces a 25 basis point rate hike on Wednesday, it will reinforce Walsh’s repeatedly emphasized commitment to restoring price stability and also indicate that policymakers are no longer relying on preemptively signaling policy moves to the market.

Flight stated:

“The market may once again be underestimating the extent of the Fed’s hawkish shift. A rate hike this week ‘would clearly mark the end of the forward guidance era’ and highlight the Fed’s independence.”

Interest rate swap markets indicate that traders currently assign about a 40% probability for the Fed to raise rates by 25 basis points on Wednesday. By recent standards for market pricing ahead of Fed decisions, there remains significant uncertainty so close to the meeting. Traders have fully priced in a hike by September.

Flight believes a rate hike this week, compared to waiting until September, would have a greater impact because it would reshape the market’s expectations of how the Fed responds to inflation.

He said that in addition to enhancing the central bank’s credibility in fighting inflation, a surprise rate hike would also affect companies’ pricing decisions and workers’ wage demands, preventing inflation from becoming further entrenched and potentially reducing the amount of tightening needed in the future.

Although recently weaker employment growth and inflation data briefly reduced market expectations for a July rate hike, Flight contends that these data should not outweigh broader evidence—namely, that inflation risks remain elevated and the labor market is still stable.

Meanwhile, geopolitical tensions in the Middle East remain volatile. Oil prices fell sharply on Monday after the United States suspended daily strike operations against Iran. However, despite the recent easing of tensions, oil prices are still up about 20% this month, as Houthi forces backed by Iran are threatening Saudi oil shipments through the Red Sea.

Flight added that the recent rise in energy prices may be a key factor driving the Fed to raise interest rates.

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