Markets are still trying to figure out the Fed’s next move

By John Towfighi, CNN

New York (CNN) — Will the Federal Reserve raise interest rates or hold them steady at its meeting next month?

For the market, it’s a coin flip: Odds of a rate hike in September are near 50%, while odds of keeping rates steady are near 50%, according to CME FedWatch, a real-time forecasting tool.

Volatile job numbers, stubborn inflation and changes to the Fed’s communications style are all stirring up uncertainty in markets and raising the stakes for upcoming economic data releases — including this week’s inflation report.

Traders are looking to Consumer Price Index data on Wednesday for more guidance on whether inflation is cooling or remaining sticky. The surge in energy prices because of the war with Iran has raised expectations for higher Fed rates by year-end, but the market remains divided on the timing of any rate hikes, while new data continues to shift bets.

Markets are pricing in a 50% chance that the Fed holds rates steady in September, but it’s a change from one week ago, when the odds for a rate hike were at 67%. The reason for the shift? Last week’s employment report unexpectedly showed the US economy lost 23,000 jobs in July, moving the odds in favor of holding rates steady.

But the upcoming inflation report could move those odds again.

Consensus estimates are for 3.4% annual headline inflation in July, down slightly from 3.5% in June. Furthermore, estimates are for core CPI, which strips out energy and food prices, to come in at 2.5% in July, down from 2.6% in June. Any surprise of hotter-than-expected inflation could prompt traders to ramp up bets on a rate hike in September. But an in-line report, or cooler-than-expected inflation, could reaffirm bets for keeping rates steady.

‘Live’ meetings under Warsh

The shifting odds are putting heightened importance on economic data, especially as traders navigate a backdrop of prolonged tensions in the Middle East, as well as the start of Kevin Warsh’s tenure as Fed Chairman. The result is that Fed meetings feel more “live,” or uncertain, than in recent years, economists say.

The Fed’s benchmark interest rate is significant for markets because it can impact the health of the economy, as well as the prices and expected value of bonds, stocks and the dollar.

Warsh has stated his preference that the Fed communicate less and let markets do more of the work in reading economic data and adjusting accordingly. Markets are continuously responding to new information and data and adjusting odds for the Fed.

It’s a new environment for markets. After the 2008 financial crisis, the Fed began more deliberately guiding the market to near certainty on the trajectory of rates heading into its meetings.

“This is definitely unusual in how much uncertainty we have going into the meeting,” Michael Pierce, chief economist at Oxford Economics, told CNN. “But that’s of course the stated preference of this Chair — to go into those meetings without a predetermined outcome or it being entirely clear to financial markets what the outcome will be.”

“So part of that is a feature rather than a bug of this new Fed chair and his preferred style of communications,” Pierce said.

Wall Street divided on Fed outlook

The war with Iran continues to add to the uncertainty. Global oil prices rebounded in July to $100 per barrel before falling in recent weeks to around $80 per barrel, though still well above pre-war levels. Meanwhile, a weaker-than-expected jobs report has dampened the argument for rate hikes in September.

There will be a series of other economic data releases across the next month before the Fed convenes in mid-September.

Still, Wednesday’s inflation report takes on heightened significance in light of the weak jobs report on Friday. The data points for July will also help set the economic backdrop ahead of the Fed’s annual Jackson Hole Economic Symposium at the end of August, where traders will search for hints on the trajectory of rates.

Wall Street economists are split on the outlook for the Fed. Economists at Bank of America and PGIM expect the Fed to raise rates at each of its three meetings before year-end. At Barclays, Jefferies, Morgan Stanley, Truist and UBS, economists expect the Fed to keep rates steady for the remainder of the year.

“The markets are struggling to digest exactly what Warsh is struggling to digest, which is what is the right path for monetary policy, and even more importantly, what is the right timing for that path,” Jeff Klingelhofer, portfolio manager at Aristotle Capital Management, told CNN.

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