In a change, traders are now betting that the Federal Reserve’s next move will be a rate hike, even as new Chairman Kevin Wersh and President Donald Trump have signaled support for lower borrowing costs.
The Fed typically lowers rates to stimulate the economy, which can spur hiring, and raises rates to curb inflation. Today, forecasters’ rising expectations for a rise appear to be a response to continued traffic disruptions in the Strait of Hormuz, which have pushed up the cost of oil, gas and related commodities, as well as positive job growth in March and April.
Although policymakers are somewhat divided on the best path forward for rates, they have not yet signaled that a hike is imminent in the near future. Rate-setting committee members on March 18 had projected a quarter-point cut in the average projection for the federal funds rate, which serves as a benchmark for interest rates nationwide, by a quarter point before the end of the year. Three members dissented from the April decision because they felt the committee’s statement was biased toward lowering rates in the future.
“The conditions for an increase are quite high, not impossible, but it is quite high,” said Mike Scordales, head of US economics at Truist. “We’ve seen a lot of things fall apart before an increase actually becomes a base case.”
Why are forecasters predicting a rate hike?
While futures markets are still largely expecting policymakers to make no changes to rates at their upcoming meetings, they now think a rate hike is more likely than a cut, according to CME Group’s FedWatch tool. As of noon on May 18, it shows about a 49% chance of an increase in December and a 58% chance of an increase in January next year.
Jordan Rizzuto, chief investment officer at GammaRoad Capital Partners, said, “All of this is a recognition of the reality that any formal resolution of the conflict in the Middle East will take much longer than expected, and the inflationary effects that were expected to be temporary will likely be far more persistent.”
According to Scordales, some of the change in expectations also appears to be driven by the global nature of futures markets. European investors grappling with the rising costs of natural gas and electricity are contributing to the rise in rate hike expectations, he said, but he said those price pressures are not occurring in the United States the same way they are in Europe.
Scordales said for a realistic estimate of a rate hike, Fed policymakers would need to see softness in retail sales and consumer spending, oil prices remaining near levels seen after Russia’s 2022 invasion of Ukraine, and increased oil costs leading to higher prices for more consumer goods. In other words, the Fed is still waiting for additional data before making its next move.
Will Warsh try to bring down rates?
Warsh’s first meeting as chair will be at the Federal Open Market Committee’s next meeting in June. As Trump’s nominee, Warsh suggested considering outright price increases and said he believed AI-driven productivity gains could act as a deflationary force.
“Theoretically, that framework takes a dovish stance,” meaning it could favor lower rates, Christian Floro, market strategist at Principal Asset Management, said in a note to USA TODAY. “In practice, a strong economy, as well as sticky inflation, may limit his ability to convince his fellow committee members.”
Even if Wersch sees lowering borrowing costs as the right move, he will need to convince a majority of the FOMC to vote with him. The committee is composed of 12 voting members. Warsh has only 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 need to be sure about how AI is going to impact the economy before you demand lower interest rates at this time.”
What do the rate changes mean for consumers?
In general, the Fed lowering its benchmark rate can lower interest rates for consumers on things like credit cards, car loans and mortgages. Rate increases have the opposite effect, but benefit savers through higher returns on high-yield savings accounts and certificates of deposit.
“There’s often a reaction, ‘Oh, well, raising rates would be a net negative for consumers because it increases the cost of borrowing,’ and what we’ve seen is that raising the policy rate over time can certainly increase the cost of borrowing, but these effects are rarely immediate,” Rizzuto said.
In theory, higher borrowing costs are designed to curb inflation by making it harder to buy on credit or take out a loan, but they don’t automatically make gas cheaper at the pump.
“Changes in interest rates do not necessarily determine whether the Strait of Hormuz is open or not,” Scordales said.