The Federal Reserve's interest rate decision and press conference will be held early Thursday morning. Although the US suspended its 13-day attack on Iran last weekend, the US inflation landscape and Fed policy expectations have undergone a dramatic reversal in just a few weeks. The July FOMC meeting, initially anticipated to be uneventful, is now expected to see more hawkish statements from Warsh. Escalating geopolitical conflicts in the Middle East, soaring international oil prices, the implementation of a new round of tariffs, and the demand dividends brought by the expansion of the AI industry have all contributed to the continued disruption of inflation, completely negating the policy breathing room provided by the June CPI slowdown. This has put the Fed in a dilemma between "maintaining interest rates unchanged" and "resuming rate hikes," further widening internal policy disagreements. Since the beginning of the year, the market, relying on the positive data of the June CPI decline, generally believed that US inflation would steadily cool down, and that the Fed would continue its wait-and-see approach, maintaining the benchmark interest rate range of 3.50%-3.75%. However, since the beginning of July, multiple negative factors have combined to completely reverse market expectations. The collapse of the fragile ceasefire agreement between the US and Iran, coupled with geopolitical tensions pushing up global energy prices and higher gasoline prices in the US, along with the Trump administration's imposition of new tariffs of 10%-12.5% on 60 countries and the continued expansion of the AI industry leading to resource supply and demand imbalances, have collectively solidified inflation stickiness, making it difficult for the Federal Reserve to achieve its 2% inflation target in the short term. Meanwhile, the yield on 30-year US Treasury bonds climbed to 5.18%, a near 20-year high, further exacerbating concerns in financial markets about runaway inflation.

Market expectations have shifted dramatically, and pricing in interest rate hikes continues to heat up.

Policy uncertainty has escalated rapidly, directly driving a significant shift in market trading logic. Although the easing of tensions between the US and Iran over the weekend slightly increased the probability of maintaining interest rates, as of July 27, data from the CME Group's FedWatch Tool showed that the market was pricing in a 66.3% probability of the Fed keeping rates unchanged at the July FOMC meeting, and a 33.7% probability of a 25 basis point rate hike. Just two weeks prior, the market was almost certain that the Fed would hold rates steady, with the probability of maintaining the current rate approaching 90%. Looking ahead, market expectations for tightening have further intensified, with the cumulative probability of a rate hike before the September FOMC meeting approaching 78%. The pricing of a cumulative 50 basis point rate hike by the end of the year fully reflects the market's anxiety about a continued rebound in inflation.

The Federal Reserve is increasingly divided, with hawks explicitly calling for interest rate hikes.

The internal policy divisions within the Federal Reserve have become public, with hawkish officials consistently signaling a tightening stance, foreshadowing a dissenting vote at this meeting. Dallas Fed President Lori Logan and Cleveland Fed President Beth Hammark, both with voting rights this year, have explicitly stated their support for a short-term rate hike. Their core logic is that current inflation is sticky and unlikely to steadily decline to the policy target, and that inflation control takes precedence over job stability. Looking back at the June meeting, the Fed kept interest rates unchanged for the fourth consecutive time, a meeting that already hinted at policy disagreements. The minutes showed that most members had already anticipated multiple inflation risks: high capital expenditure in the AI industry, ongoing geopolitical conflicts in the Middle East, and the implementation of new tariff policies. These three variables could all drive inflation to a prolonged high level, and it was clear that a rate hike would be fully justified once these scenarios materialized. In recent months, all the previously anticipated risks have materialized, further strengthening the hawkish demand for tightening. If the Fed continues to choose to wait and see at this meeting, a dissenting vote is highly likely.

The battle between bulls and bears is nearing equilibrium, leaving policymakers in a dilemma.

Compared to the hawkish stance, the Federal Reserve's overall policy tone remains cautious and wait-and-see, with the internal power struggle between bulls and bears reaching a balance. William Inge, a former senior economist at the Federal Reserve and a graduate of Yale University, stated bluntly that both raising interest rates and maintaining them unchanged have sufficient logical support, and the Fed is caught in a typical policy dilemma. Dovish and centrist officials believe that the cooling inflation data in June is indicative; if the subsequent transmission of energy price increases to end-market prices is limited and the job market weakens marginally, the Fed can continue its wait-and-see approach, and may even reserve room for future rate cuts. Federal Reserve Vice Chairman Philip Jefferson also signaled a compromise, stating that the Fed will continue to monitor inflation trends and will promptly reassess its monetary policy stance if the cooling is less than expected. In addition to the inflation data disturbances, the change in Federal Reserve Chairman Kevin Warsh's policy communication style has further amplified market uncertainty. Compared to the clear forward guidance model of the past, this Federal Reserve has significantly weakened policy expectation guidance, no longer releasing signals about the interest rate path in advance, and has shifted to a purely data-driven decision-making model. Warsh repeatedly reiterated at congressional hearings that he would adhere to the policy bottom line of price stability and rely on monetary policy tools to suppress inflation, but he consistently avoided providing clear guidance on the pace of policy, causing the market to be unable to anchor its policy direction and resulting in a continuous battle between bulls and bears.

Institutional view: July becomes a key window for interest rate hikes

Industry analysts point out that the policy decisions made at the July FOMC meeting also implicitly included key political and credibility considerations. Joseph Lavorgner, chief economist for the Americas at SMBC Nikko Securities, stated that the current rate hike can help Walsh rebuild his credibility in combating inflation, and compared to adjusting rates closer to the US midterm elections in November, this rate hike faces less political controversy and public pressure. Looking back, the Fed's rate cuts before the 2024 election were publicly criticized by Trump, who accused them of political interference in monetary policy. To avoid similar controversies, stabilize long-term interest rates, and alleviate White House doubts about monetary policy, July became the optimal window for the Fed to implement a rate hike. The current financial market has entered a two-way risk hedging mode, with funds no longer unilaterally betting on policy direction. Pradeep Bhatia, CEO of derivatives firm Derivative Path, observed that among his institutional clients, one-third are betting on a rate hike this year, while the rest are actively hedging against rate cuts, resulting in an extremely polarized market. Former New York Fed President Bill Dudley also warned that the Fed's inflation has been out of control for five years, and if policy continues to be slow and verbal anti-inflation measures are out of sync with actual actions, it will seriously damage the central bank's policy credibility.

Although an interest rate hike is unlikely, the market may continue to face hawkish rhetoric.

When the CPI was released, Warsh emphasized a hawkish stance of zero tolerance for inflation. Regardless of whether this was ostensibly to maintain the Fed's independence but actually to meet the White House's needs, the recent resurgence of the US-Iran conflict means that statements regarding inflation must be even more cautious than before. Furthermore, a rate hike would be a black swan event, which is highly unlikely. The market will focus on Warsh's post-meeting press conference; while the Fed is expected to maintain interest rates, it is highly probable that he will deliver an even more hawkish statement.