US Federal Reserve faces tough test between holding rates steady and raising them

Arabic - Global financial markets are entering a week that could shift their trajectory, as investors await the US Federal Reserve’s decision on interest rates in one of its most opaque meetings in years.

Meanwhile, oil has once again upended calculations amid renewed tensions in the Middle East, and inflation risks have returned to the forefront as the Fed convenes amid a clear divide within policy-making circles.

According to the Wall Street Journal, officials at the previous meeting were nearly evenly split: one camp argued that raising interest rates could become necessary during the year, while another believed the current policy was sufficient, making the decision even more complex.

It is clear that any new and prolonged wave of rising energy prices could make headline inflation more stubborn, especially as core inflation remains at 2.6%, above the Fed’s 2% target. This is precisely why markets are recalibrating their expectations.

The pricing of futures contracts has raised the probability of an interest rate hike at the July 28-29 meeting to around 40%, up from just 10% a few days ago. However, these figures do not capture the full uncertainty, as another key factor is Fed Chair Kevin Warsh, who speaks forcefully about the need to restore price stability, but has not yet clearly indicated whether he believes this requires an immediate rate hike or waiting. This is exactly what makes tomorrow’s meeting distinct.

A rate hike would send a clear message that the Fed is prepared to act swiftly against any new inflationary threat. Conversely, holding rates steady would not end the debate but might simply postpone it to September. Therefore, investors this week are not merely awaiting a decision on a quarter-point rate change.

The bigger question remains: Which Fed will we see? Will it be one prepared to return quickly to tightening if inflation risks intensify? Or will it prefer to buy more time before its next move?

In either case, the biggest market moves may not occur at the moment the decision is announced, but with every word Warsh says about inflation and the future path of interest rates.