Federal Reserve rate cut expectations fall below 1 for the first time this year! Will oil price surge trigger a global rate hiking cycle?

Cailian Press, March 13 (Editor: Xiaoxiang)
Latest signs indicate that as energy prices soar and inflation concerns emerge, market expectations for the Federal Reserve to cut interest rates are weakening, while a global rate hike wave is likely to arrive more quickly…

In recent days, traders have quickly abandoned expectations that the Fed will ease monetary policy in early summer. This shift in thinking comes amid the US-Israel attack on Iran and oil prices surging to around $100 per barrel.

According to CME FedWatch calculations, before the recent Middle East conflict, the market expected the Fed to cut rates by 25 basis points in June, with another cut in September, and a very small chance of a third cut later this year based on economic data. The main logic behind this outlook was: a softening labor market, slowing inflation, and the upcoming appointment of a dovish new Fed chair in May would push the Fed toward easing.

But the sudden outbreak of conflict in Iran at the end of last month has undoubtedly disrupted all of this.

FedWatch’s latest probabilities show that traders in the federal funds futures market have largely ruled out a rate cut in September, now believing the Fed may only cut once in December.

Meanwhile, interest rate swap contracts tied to the Fed’s policy meeting dates show that swap traders are no longer 100% certain the Fed will cut rates this year…

As shown in the chart below, overnight, swap traders only expected a 17 basis point cut this year — less than a single 25 basis point cut. Later Wednesday, this expectation was around 40 basis points.

Whether this outlook can be maintained may depend on how the Middle East situation develops. If tensions ease, markets might return to normal and reignite hopes for more easing. But if shipping through the Strait of Hormuz remains disrupted and oil prices continue to spike, global interest rates could rise further.

Notably, as of this Wednesday, the global bond market has given back nearly all of its gains since the start of the year. Not just U.S. Treasuries, but yields in the UK, Germany, Australia, and Japan have all surged significantly.

Currently, the Bloomberg Global Aggregate Bond Index, which tracks total returns of investment-grade government and corporate bonds, is roughly flat compared to early this year. Earlier, oil prices surged past $100 per barrel on Thursday, continuing the global bond sell-off. The index had risen as much as 2.1% earlier in the year (as of February 27), but then President Trump’s attack on Iran highlighted how geopolitical shocks can quickly reverse market sentiment.

As war costs continue to rise, the risk of expanding fiscal deficits increases, prompting investors to demand higher returns on long-term bonds. Coupled with inflationary pressures from soaring energy prices, this creates a highly uncertain environment for fixed-income investors.

This week, U.S. Treasury yields climbed further to multi-month highs, with the widely watched 10-year Treasury yield rising 4.9 basis points on Thursday to 4.255%, the highest since February 5. This indicates that investors are pricing in the increased risk of conflict escalation. Many fund managers are betting that inflationary pressures will outweigh traditional safe-haven demand for sovereign bonds.

It’s easy to foresee that as multiple central banks, including the Fed, hold rate decisions next week, their monetary policy choices amid geopolitical tensions and rising oil prices will be a major focus.

Unlike the Fed, which still leans toward rate cuts, market traders’ expectations for other major central banks are increasingly leaning toward more rate hikes within the year:

Based on current rate pricing, traders expect the Bank of England to raise rates by about 10 basis points, the European Central Bank by about 40 basis points, the Bank of Canada by about 30 basis points, and Australia’s Reserve Bank, which already raised rates in February, may further hike by about 65 basis points…

(Cailian Press, Xiaoxiang)