The Fed Has Cover — Now Comes the Hard Part

The Fed Has Cover — Now Comes the Hard Part

• Short-term consumer inflation expectations are on the rise.

• The Global Supply Chain Pressure Index has been rising.

• Both measures could give policymakers cover to raise rates.

The Federal Reserve has cover to raise interest rates; the question now is if it will…

This week brings another important update for domestic monetary policy. The Federal Open Market Committee will refresh its stance on the federal funds target range. According to the Chicago Mercantile Exchange’s FedWatch Tool, interest rates are expected to remain unchanged…

But as we can see in the above chart, Wall Street doesn’t expect that stance to last very long. The CME’s conditional meeting probability tool shows bond‑market speculators anticipating two more rate hikes before year‑end — one in September and another in December.

There’s good reason investors are leaning toward higher rates. With the recent re‑escalation of tensions between the U.S. and Iran, oil prices have jumped. From March through May, higher gas prices were the single biggest driver of domestic inflation. Headline annualized CPI growth climbed from 2.4% in February to 4.2% in May. And unless something changes, Wall Street is worried inflation could head higher once more.

But that’s not the only indicator pointing toward higher rates. Several other gauges suggest price pressures could materialize in the coming months. And without a sudden cessation of hostilities in the Middle East, they could give Fed Chairman Kevin Warsh the justification he needs to introduce a rate hike and end the speculation.

But don’t take my word for it, let’s look at what the data’s telling us..,

Consumer Inflation Expectations

If we want to understand the Fed’s inflation outlook, the first place to look is consumer expectations. The central bank monitors this closely to gauge whether households are worried about rising costs. Policymakers fear that if individuals believe prices are headed higher, they’ll start to stockpile goods, causing supply to dwindle. That would be a self‑fulfilling outcome, as reduced availability forces prices, and inflation, higher.

We can see this in the New York Fed’s consumer expectations survey…

As shown in the chart…

• Short-term inflation expectations have been moving up.

• In June, the number hit 3.7% compared to the recent low of 3% in February.

• This is the highest reading since the Fed last raised rates.

While the latest result is only slightly above the mid‑2025 peak, it still makes policymakers uncomfortable. Ideally, they’d like to see expectations drift back toward the long‑term average of 2.8%. To be fair, the three‑ and five‑year numbers have barely moved. But given the recent gains in short‑term expectations, it wouldn’t be surprising to see the Fed consider a pre‑emptive rate hike to head off the problem.

Global Supply Chain Pressure Index

Another place to look for inflation pressure is the New York Fed’s Global Supply Chain Pressure Index (“GSCPI”). It measures supply‑chain stress across the global economy, incorporating transportation data and PMI survey responses on lead times, inventories, and backlogs. The gauge tracks changes in standard deviations.

Stress has been rising…

In the chart…

• GSCPI was almost 2 standard deviations above normal in April and May.

• The gauge pulled back to 1.25 in June.

• Readings haven’t been this high since early 2023.

The last time supply‑chain pressures accelerated above two standard deviations was early 2021. COVID restrictions made it difficult for companies to move goods around the globe. Delays and dwindling inventories pushed prices higher. We’re not in the same situation today, but reduced transport through the Strait of Hormuz is causing disruptions. Elevated supply‑chain pressure could be another reason for the Fed to act proactively.

Gasoline Prices

As mentioned at the outset, rising oil prices have been the main catalyst for the recent jump in inflation. Oil is refined into gasoline, which plays a central role in daily consumer spending. We can track changes through the Energy Information Administration’s average retail gas price index.

After rising from March through May, the gauge fell sharply in June. But over the last couple of weeks, it has begun to climb again…

The monthly data shows…

• Prices surged 24% in March, driving inflation up.

• They dropped more than 9% in June, pulling inflation down.

• They’re still off 4% in July, but closer to the seasonal decline of 1%.

July began on weaker footing. According to the EIA’s weekly numbers, gas prices averaged $3.91 in the first week, below the June low of $3.94. But over the last two weeks, prices have jumped back to $4.13 per gallon. That’s still below the May average of $4.61, but it’s enough to make policymakers uncomfortable.

Bringing It All Together

After weeks of Wall Street anxiety about whether the Fed will raise rates, the rubber is about to meet the road. Personally, I think the Fed can still afford to wait. While the situation between the U.S. and Iran appears to be at its worst, the two sides are still talking. It would be unfortunate to see rates rise only for the central bank to reverse course shortly thereafter.

However, based on the data we just reviewed, the Fed has the cover it needs to hike. And frankly, it wouldn’t be the worst outcome. It would end the speculation. At the end of the day, a pre‑emptive move to keep the economy on course should continue to underpin a steady rally in the S&P 500 Index.

Five Stories Moving the Market:

U.S. President Donald Trump has set aside, at least for now, plans to sharply escalate the American military assault against Iran; the latest turn in Trump’s handling of the conflict with Iran came after a meeting on Friday with top advisers and senior members of his cabinet – NY Times. (Why you should care – the shift is a signal the U.S. would still prefer to find a resolution rather than intensifying the conflict)

Iran will halt its own ​attacks as long as the United States does the same, according to a senior Iranian official; the development comes as the United States pressed ‌pause on its bombing campaign – Reuters. (Why you should care – the pause leaves the door open for both sides to return to the negotiating table)

OpenAI CEO Sam Altman heads to Washington, D.C., this week to preview the company's most powerful AI yet, pushing for speedy approval of a model that just hacked a real company – AXIOS. (Why you should care – Altman is likely to highlight how his more powerful model can improve efficiency and productivity for businesses)

A coalition of technology companies led by Nvidia and Microsoft called on policymakers to promote the development of open-weight artificial intelligence models, positioning it as key to ensuring the U.S. maintains technological leadership – Bloomberg. (Why you should care – open-weight AI models will help to bring down costs for corporate America, boosting demand for compute capctiy as well as the infrastructure equipment that makes it possible)

South Korea announced $950 billion in new ​AI initiatives involving Samsung Electronics, SK Group, and U.S. tech firms as global AI leaders rush to fill a shortage of faster chips to power and develop ‌more advanced systems; SK Group has signed deals worth $750 billion, including SK Hynix’s partnership with Nvidia valued at more than $500 billion – Reuters. (Why you should care – the announcements point to the continued strength for compute capacity and the infrastructure components needed to build it)

Pre-Market Levels:

S&P Futures +0.98%, Nasdaq Futures +1.60%, Dow Jones Futures +1.03%, Russell 2000 Futures +1.32%

Europe:

EuroStoxx 50 +1.28%, UK FTSE +0.47%, German DAX +1.58%, French CAC +0.75%, Italian MIB +0.80%, Spanish IBEX +1.36%

Asia:

Japan's Nikkei +0.50%, Japan's TOPIX +1.63%, China's Shanghai Composite +1.15%, Hong Kong Hang Seng +0.98%, South Korea's KOSPI +0.97%, Taiwan's TSE -0.02%

Currencies:

Dollar -0.20%, Euro +0.23%, Japanese Yen +0.14%, British Pound +0.08%, Canadian Dollar -0.07%, Swedish Krona +0.31%, Swiss Franc +0.37%

Risk:

VIX -5.38%, Bitcoin +1.31%, Ethereum +4.36%

Growth:

WTI Crude -6.85%, Brent Crude -8.00%, Nat Gas -3.77%, Copper +0.62%

Safety:

Gold +0.60%, Silver +0.91%

Sovereign Bonds:

U.S. Treasury 10-yr yield -4.0bps at 4.639%

U.S. Treasury 2-yr yield -2.8bps at 4.303%

German 10-yr yield -4.1bps at 3.132%

French 10-yr yield -5.4bps at 3.914%

U.K. 10-yr yield -5.1bps at 4.984%

Japanese 10-yr yield -0.2bps at 2.776%

Economic Calendar:

Earnings: AMKR, APLD, AZN, CDNS, FFIV, NUE, PFG, WELL

China – Industrial Profits YTD for June (Sunday)

Germany – Ifo Business Climate Index for July (4 a.m.)

U.S. – Durable Goods Orders for June (8:30 a.m.)

U.S. – Dallas Fed Manufacturing Index for July (10:30 a.m.)

Treasury Auctions $92 Billion in 13-Week Bills (11:30 a.m.)

Treasury Auctions $79 Billion in 26-Week Bills (11:30 a.m.)

Treasury Auctions $69 Billion in 2-Year Notes (1 p.m.)

Treasury Auctions $70 Billion in 5-Year Notes (1 p.m.)

RBA’s Bullock (Governor) Speaks (11:05 p.m.)