Rate-hike wagers rebuild across the Fed, BOE, and ECB

Western central banks are edging toward tighter policy as an oil spike revives inflation fears on both sides of the Atlantic. Markets now put the odds of a July Fed hike at roughly even, up from less than 10% at the start of the month, with the two-year Treasury yield holding above 4.25%, widening its premium over the Fed’s policy rate, Bloomberg reports.

Early Fed signals fueled the shift: Odds firmed after Fed Governor Christopher Waller said the central bank should consider raising rates “in the near term” if core inflation delivers “another hot reading.”

Inflation is expected to cool for the first time since January: Economists see June CPI easing on both the headline and core measures for the first time since the start of the year, with annual inflation slowing to 3.8% from 4.2% and core to 2.8% from 2.9%. Headline prices are forecast to drop 0.1% m-o-m; core to rise 0.2%.

Traders want tightening anyway: Softer projections notwithstanding, the market reads higher rates as the price of getting inflation to target. Two forces are doing the work — crude climbing toward USD 90 a barrel as US-Iran tensions escalate, and Fed Chair Kevin Warsh’s refusal to signal his hand ahead of his semiannual testimony to Congress this week.

Markets see the tightening running well into next year: Rate futures now price one Fed hike by year-end and a second by mid-2027. Columbia Threadneedle’s Ed Al Hussainy expects more — a full unwind of all three quarter-point cuts the Fed made over the final four months of last year against a softening labor market, further than the market is pricing. Hike wagers have driven open interest in August fed funds futures up about 23% this month.

The Bank of England (BOE) and the European Central Bank (ECB) face the same pressure, with the oil run-up reviving inflation concerns across Europe. Markets are fully pricing a quarter-point BOE hike by September and another before year-end; the ECB is seen raising 25 basis points in September, with a second move by year-end all but locked in, Bloomberg reported separately.

Europe’s exposure runs through energy imports: Swaps priced less than a quarter-point of combined BOE and ECB tightening through next year as recently as the start of this month. The blockade on shipping through the Strait of Hormuz changed that, leaving the import-dependent UK and Euro area squarely in the path of oil-driven inflation.

Conviction may not hold, though. BMO’s Ian Lyngen expects the market’s belief in a July move to soften after this week’s CPI print and Warsh’s testimony, held up only by Warsh’s aversion to guidance. ING strategist Padhraic Garvey makes the threshold case: at today’s crude levels, another hike is a high bar, but sustained higher oil would make one “more of a baseline outcome.”

What to watch: The 29 July FOMC meeting is where the market expects Warsh’s first hike to land (if it comes).

MARKETS THIS MORNING-

Asia-Pacific markets opened higher this morning as an unexpected drop in US inflation cooled interest rate hike fears, while oil stabilized following Washington’s move to drop a shipping levy it had threatened in Hormuz. South Korea’s Kospi led the regional rally, gaining 6.3%, while Japan’s Nikkei was up 0.7%.

The values in the table above are listed according to the market position as of 3:30pm IST / 2pm GST.