Fed to raise rates this week? Citadel Securities: A rate hike by Warsh this week would bolster anti-inflation credibility and end the era of forward guidance

Citadel Securities expects the Federal Reserve to raise interest rates at this week's meeting—a surprising move that would enhance the credibility of Fed Chair Kevin Warsh in the fight against inflation.

Frank Flight, the firm's head of macro strategy, wrote in a report that if the Fed announces a 25-basis-point rate hike on Wednesday, it would reinforce Warsh's repeated emphasis on restoring price stability, while also signaling that policymakers are no longer relying on telegraphing policy moves to the market in advance.

Flight stated:

"The market may once again be underestimating the extent of the Fed's hawkish pivot. A rate hike this week 'will clearly mark the end of the era of forward guidance' while highlighting the Fed's independence."

Interest rate swap markets show that traders currently assign approximately a 40% probability to a 25-basis-point rate hike by the Fed on Wednesday. By recent standards for market pricing ahead of Fed decisions, such significant uncertainty so close to the policy meeting is notable. Traders have already fully priced in a rate hike in September.

Flight believes that raising rates this week, rather than waiting until September, would have a greater impact, as it would shift market expectations regarding how the Fed intends to tackle inflation.

He said that beyond strengthening the central bank's anti-inflation credibility, a surprise rate hike would also influence corporate pricing decisions and workers' wage demands, preventing further entrenchment of inflation and potentially reducing the magnitude of tightening needed in the future.

Although weaker-than-expected job growth and inflation data recently dampened market expectations for a July rate hike, Flight argued that these figures should not outweigh broader evidence—namely, that inflation risks remain elevated and the labor market remains stable.

Meanwhile, geopolitical tensions in the Middle East remain volatile. Oil prices fell sharply on Monday after the U.S. paused daily strikes against Iran. However, despite the recent easing of tensions, oil prices have still risen by about 20% this month, as Iran-backed Houthi forces continue to threaten Saudi oil exports transported through the Red Sea.

Flight added that the recent rise in energy prices could be a key factor driving the Fed to raise interest rates.