Fed in July: A Weaker Case for Hiking

Morgan Stanley's Michael Gapen and Matthew Hornbach discuss the July FOMC meeting, expecting the Fed to hold rates. The case for hiking has weakened due to moderating employment and disinflation, though risks like higher oil prices and a potential new reaction function from Chairman Warsh could shift the outlook. They also examine how bond markets are pricing a hawkish Fed via rising real yields correlated with energy prices, and consider whether reduced Fed communication could increase volatility. - The Fed is expected to keep the federal funds rate unchanged at 3.5-3.75% in July. - The case for a hike weakened because employment growth slowed and disinflation signals emerged in goods and services. - Possible reasons to hike include prolonged oil price risks, balance-of-risk shifts toward inflation, and a new, more hawkish reaction function from Chairman Warsh. - Bond market moves show real yields rising alongside energy prices, suggesting investors expect the Fed to react to higher oil, not look through it. - Fewer FOMC participants speaking publicly may create an information vacuum that could increase market volatility. - The September meeting, after Jackson Hole, will have more data and could be a venue for a rate hike if inflation stays firm.