The escalation of the situation between the US and Iran has sparked concerns about inflation! The market is betting that the probability of the Fed's interest rate hike in July will continue to rise

The Zhitong Finance App learned that although futures traders and forecasters still generally expect that the Federal Reserve will once again stand still at the July meeting, the possibility that the central bank will act at that time is rising. On Monday, market bets on the Federal Reserve's interest rate hike continued to heat up. According to CME's “FedWatch” tool, the current market predicts that the probability that the Fed will raise interest rates by 25 basis points on July 29 has risen to 46.5%, up from 34% last Sunday. On the prediction market platform Kalshi, traders currently expect the probability that the Fed will raise interest rates at 36%, higher than the level of less than 20% last Sunday, and far higher than the probability of less than 10% at the beginning of this month.

Market expectations for the Federal Reserve's interest rate hike are heating up after US President Trump announced the re-imposition of the blockade on Iranian ports near the Strait of Hormuz and the imposition of a 20% transit fee on all goods transported through the strait. With the recent tension in the US and Iran, international oil prices have risen again, increasing market concerns that inflation will remain high for a longer period of time and force the Federal Reserve to raise interest rates.

Therefore, investors will pay close attention to the upcoming release of key inflation data such as the US Consumer Price Index (CPI) and wholesale prices for June. This will be the last batch of inflation data released by the Federal Reserve before holding an interest rate meeting later this month, so it will provide an important clue for evaluating future interest rate prospects. Economists expect that the overall US CPI in June and the core CPI, excluding food and energy prices, will both slow slightly from May — the US CPI is expected to rise 3.8% yoy in June, lower than the 4.2% year-on-year increase in May — but both indicators will still be significantly higher than the Federal Reserve's 2% inflation target.

Against the backdrop of another escalation in the US and Iran situation and the continued rise in oil prices, the outlook for inflation is likely to become more complicated. According to a research report released by Barclays on Monday, market concerns about inflation are no longer limited to energy prices.

Ajay Rajadiaksha, head of global research at Barclays, said that the cost transmission effect caused by the impact on oil prices is not over yet, while continued high energy prices have not led to a significant drop in demand, which has further intensified inflationary pressure. He also said that the rise in prices driven by artificial intelligence (AI) is also further worsening the outlook for inflation.

Rajadiaksha wrote that these factors combined to create a situation where the Federal Reserve may have to adopt an increasingly hawkish policy stance. He said, “A data-dependent policy framework means that the Federal Reserve must not only respond to published inflation data, but also respond to future inflation forecasts.” “I'm afraid none of the inflation data to be released in the next few months will look very good.”

Additionally, Federal Reserve Chairman Walsh will attend congressional hearings on Tuesday and Wednesday. At that time, Fed observers will pay close attention to his views on inflation, the labor market, and economic growth, and how these factors interact with interest rates. However, if you take his consistent style in recent public appearances as a reference, I'm afraid these observers will still get very little. Walsh has promised to abandon the central bank's so-called “forward-looking guidance” — a signal about the path of interest rates. At his first press conference on June 17, he declined to answer a number of related questions. For example, when asked how patient policymakers are in waiting for inflation to fall back, he responded, “Your question sounds like encouraging me to give forward-looking guidance.”

Federal Reserve Governor Christopher Waller said on Monday that the current US inflation situation is still worrying, but the Fed should not rush to raise interest rates again by drawing lessons from the delay in dealing with inflation in 2021, but should wait for more economic data to determine the trend of inflation and the driving factors behind it. Speaking in New York on the same day, Waller said that the current inflationary pressure is not only due to rising tariffs and energy prices, but is also affected by factors such as demand expansion driven by AI investment. This is also one of the important reasons why inflation continues to rise above the Fed's 2% target.

However, he stressed that the Federal Reserve needs to avoid “repeating the same mistakes.” Waller said, “I am well aware of the mistakes we made when we failed to deal with high inflation in a timely manner in 2021, and I am determined to avoid making the same mistakes again. But that doesn't mean interest rates should be raised immediately in the face of current inflationary pressure.”

Waller believes that there are still “good reasons” to believe that inflation will gradually decline in the future, but there is also a “perfectly reasonable” scenario where inflation remains high or even rises further, so monetary policy needs to be further tightened in the short term. He pointed out that the Federal Reserve is currently evaluating multiple factors driving inflation, including the tariff policy implemented in 2025, the rise in energy prices due to the situation in the Middle East, and the demand spillover effects brought about by AI investment. “We must neither tighten policy prematurely because our last action was too slow, nor repeat the mistakes of 2021 to 2022, and act too late in dealing with inflation.”

Waller believes that compared with the previous round of inflation, the Federal Reserve currently has two favorable conditions. First, the labor market is still stable and has not become the main source of inflation; second, long-term inflation expectations are generally stable. At least market indicators still show that the public maintains confidence in long-term inflation. Despite this, he warned that policymakers should not take it lightly. Waller said, “I often hear people think that as long as inflation expectations remain stable, there is no need for central banks to respond to higher than target levels of inflation. This view is wrong. Just keeping an eye on inflation and hoping it will fall back on its own is not a viable policy choice.”