Is there a 30% chance of the Federal Reserve raising interest rates next week?

Author: Li Jia

Under the dual impact of rising oil prices and the lack of forward guidance from the Federal Reserve, the market has begun to re-evaluate policy risks.

Although mainstream economists unanimously expect the Federal Reserve to remain unchanged next week, the implied probability of a rate hike in the interest rate market has risen to about 30%, pushing U.S. Treasury yields higher across the board. Among them, the two-year Treasury yield has reached a new high since early 2025, the 10-year yield has risen to a year-to-date high, and the 30-year yield is approaching its highest level since 2007.

A research report released by Citigroup on July 23 believes that this market pricing does not mean that investors generally bet on an imminent rate hike by the Federal Reserve, but more reflects that, in the context of increasingly vague forward guidance and oil prices raising inflation risks, investors are demanding a higher risk premium to cope with policy surprises.

U.S. Treasury yields rise, market prices in about 30% rate hike probability

Recently, the escalation of the situation in the Middle East has driven international oil prices to continue rising, reigniting market concerns about the return of inflation, which has led to a continuous rise in U.S. Treasury yields.

On Thursday, the two-year Treasury yield, which is most sensitive to monetary policy, rose to about 4.365%; the benchmark 10-year Treasury yield also refreshed its year-to-date high; the 30-year Treasury yield rose to 5.19%, just a step away from its high since 2007.

At the same time, interest rate futures indicate that the Federal Reserve's meeting next week has an implied rate hike probability of about 30%. However, this pricing is clearly at odds with mainstream expectations. A Bloomberg survey shows that none of the 70 economists surveyed expect the Federal Reserve to raise rates next week.

Citigroup: 30% is not a market prediction, but a risk premium

For this seemingly contradictory phenomenon, Citigroup provides a different explanation.

Citigroup economists Andrew Hollenhorst, Veronica Clark, and Gisela Young point out that the 30% in market pricing does not represent that investors truly believe there is a 30% probability of a rate hike by the Federal Reserve, but rather includes an additional risk premium.

The report believes that since there is almost no possibility of a rate cut at next week's meeting, the policy risk is inherently skewed to one side. If the Federal Reserve unexpectedly raises rates, the impact on the bond market will be far greater than if they remain unchanged, so investors are willing to pay extra costs to price in this tail risk in advance.

Citigroup notes that historically, the risk premium corresponding to Federal Reserve meetings has typically been only 1 to 2 basis points, but as the Federal Reserve has reduced forward guidance in recent years and policy communication has become more data-dependent, uncertainty has increased, and the risk compensation demanded by the market has also expanded.

This logic can also explain the current trend of long-term rates. Citigroup believes that if a future meeting unexpectedly raises rates, the market often views it as the beginning of a new rate hike cycle rather than an isolated event, so expectations for terminal rates will also rise accordingly. For this reason, the market has priced in more than 50 basis points of cumulative rate hikes by March next year, but this does not mean it is the baseline scenario for investors.

Citigroup: The more vague the forward guidance, the easier it is for rates to remain high

Citigroup believes that the recent rise in oil prices is merely a catalyst for the market to reassess the policy path, with deeper reasons lying in the changes in the Federal Reserve's communication framework.

The report points out that the situation in the Middle East has pushed up oil prices and U.S. gasoline prices, reinforcing market concerns about the resurgence of inflation risks. In the absence of clear policy guidance from Federal Reserve officials, this uncertainty further amplifies the market's worries about policy surprises.

Citigroup emphasizes that during periods of clear forward guidance, market risk premiums can usually be ignored; but currently, each monetary policy meeting carries greater policy uncertainty, and investors need to pay risk compensation in advance for potential surprises.

This means that even if the Federal Reserve ultimately remains unchanged, U.S. Treasury yields may not significantly decline due to the fading of rate hike expectations. Citigroup believes that until the Federal Reserve re-establishes a clearer communication framework, the phenomenon of rates being pushed higher by risk premiums may continue to exist.