Fed Hike Mispricing Oil Shock

"Traders are now pricing in a 62% chance of the Fed holding rates at its September meeting, according to CME's FedWatch Tool. Before the July inflation data was released, bets were split between a hike and no change."

"Daly is worried about how the public might respond to another chapter of renewed inflation and noted that if it looked like inflation momentum was again building, the Fed might need to respond aggressively to get price pressures back to the target."

"Inflation remains elevated relative to the Committee's 2 percent goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy. It has gone up since the start of the year largely due to a spike in energy prices likely caused by the U.S. conflict in Iran."

"I increasingly believe that monetary policy does have an important role to play in addressing a series of successive supply shocks that might lead to entrenched higher inflation. The 1970s inflation surge was largely supply-driven and officials ultimately concluded that tight monetary policy was necessary to bring inflation back down."

""We think the market is ultimately telling us (and Warsh) that talk is cheap with the combination of these moves, and that it is not enough to just say and proclaim that price stability is paramount... the Fed has to eventually walk the talk on inflation under this new regime.""

"strategist Howard Du, who thinks the market is mispricing the risk of rate hikes heading into Wednesday's policy meeting. 'The current long dollar positioning prices some lingering risk premium of a hawkish Fed outcome for the July meeting,' said Du."

"Memo to new Federal Reserve boss Kevin Warsh: Don't believe the hype – we're not coming out of a pandemic anymore. And hiking interest rates now would be a major mistake. Oil fully drove inflation's uptick and recent easing."

"Rate markets assign roughly a one-in-three chance that the Fed delivers a quarter-point hike to 4% on Wednesday, with a September move priced at nearly 80%."

"Could the Fed surprise markets with a rate hike on Wednesday? It's certainly possible, although it wouldn't come as a complete shock — on Monday, fed funds futures pricing of a quarter-point hike reached 40% at one point... Wednesday's decision is the most uncertain in two years and one of the least certain in over four years."

"A move this week would have a greater impact than waiting until September because it would reshape expectations about how the Fed responds to inflation. A surprise increase would influence businesses' pricing decisions and workers' wage demands before inflation becomes more entrenched, potentially reducing the amount of tightening needed later."