The Fed Under Waller: A Tough Puzzle!

76 economists unanimously predict no change, but traders are betting on fierce divergence.

Written by: Zhao Ying, Wall Street Insights

With only a few days left until the Federal Reserve's next meeting, the market's judgment on its policy direction remains highly divided—this is extremely rare in recent years. New Chair Waller has completely abandoned the forward guidance approach favored by his predecessor, fundamentally reshaping the information game between traders and the Fed.

The interest rate swap market shows that traders currently estimate a roughly 30% probability of a 25 basis point rate hike at the July 29 meeting, with a 70% probability of maintaining the current rate. Such a significant divergence so close to the meeting date is unprecedented in recent years.

According to Bloomberg on Thursday, Jim Bianco, president and macro strategist at Bianco Research, stated: "Without forward guidance, we will frequently see probability distributions of 20%, 30%, and 40%. The market is transitioning to this new way of thinking."

The direct impact of this uncertainty has already manifested in the bond market. For traders betting on the Fed's direction, getting it right will yield greater rewards, while getting it wrong will lead to larger losses. The interest rate swap market has fully priced in a 25 basis point hike in September and implies more than two cumulative hikes before March next year.

Waller Breaks Tradition: Forward Guidance Becomes History

Since taking office in May, Waller has clearly stated that he will abolish the Fed's long-standing practice of signaling interest rate paths to the market in advance. He believes that forward guidance unnecessarily constrains policymakers when economic conditions change.

This stance sharply contrasts with that of his predecessor Powell. During Powell's tenure at the Fed, officials typically conveyed clear signals to the market through speeches or media channels before meetings. The last time the market faced a similar level of uncertainty regarding meeting outcomes dates back to September 2024—when traders were divided over whether the Fed would cut rates by 25 or 50 basis points, and Powell ultimately chose the larger cut to support a weakening labor market.

Inflation Pressures and Geopolitical Risks Intertwined: Rate Hike Expectations Fluctuate

Although Waller refuses to provide forward guidance, he has clearly expressed a heightened vigilance regarding inflation. Since the pandemic, U.S. inflation has consistently exceeded the Fed's 2% target, leading the market to believe that a rate hike this year is inevitable, with the only debate being the timing.

Bond traders leaned towards maintaining rates last week—when the U.S. Consumer Price Index saw its first decline in six years, cooling expectations for a near-term rate hike. However, the renewed escalation of the U.S.-Iran conflict subsequently pushed oil prices higher, causing rate hike expectations to rebound.

Rare Divergence Between Economists and Traders

Notably, the group of economists is far more certain about the outcome of next week's meeting than traders. According to a Bloomberg survey of 76 economists, all respondents expect the Fed to maintain the benchmark rate in the range of 3.5% to 3.75% during the meeting on July 28-29.

The divergence among traders is more pronounced. John Brady, managing director at RJ O'Brien, stated: "I still don't think the Fed will raise rates next week, but the market tells me that the voting outcome will be closer than I expect."

This rare disconnect between economists and the market is itself a reflection of the market ecological changes brought about by Waller's new style—in an era absent of forward guidance, the noise of price signals will be significantly amplified, and uncertainty may become the new norm.