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

Latest signs indicate that as energy prices soar and inflation concerns emerge, market expectations for a Federal Reserve rate cut 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 coincides with the US-Israel attack on Iran and oil prices surging to around $100 per barrel.

According to CME FedWatch, before the recent Middle East conflict, markets 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 performance. The main logic behind this was: a softening labor market, slowing inflation, and a new dovish chair taking office 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 that.

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

And 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 could return to normal and hopes for easing policies could reignite. But if shipping through the Strait of Hormuz remains disrupted, soaring oil prices could push global interest rates higher.

It’s worth noting that by 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 for investment-grade government and corporate bonds, is roughly flat compared to the start of the year. Earlier this week, oil prices rebounded above $100 per barrel, continuing the global bond sell-off. The index had risen as much as 2.1% earlier this year (as of February 27), but then President Trump’s attack on Iran highlighted how geopolitical shocks can quickly reverse market sentiment.

As the costs of war continue to rise and fiscal deficits face expansion risks, investors may 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 to 4.255% on Thursday — the highest since February 5. This indicates that investors have priced in the increased risk of conflict escalation. Many fund managers are betting that any 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 amid geopolitical tensions and rising oil prices, their monetary policy choices will become a focal point.

Unlike the Fed, which still leans toward rate cuts, market traders’ expectations for other major central banks are increasingly leaning toward more rate hikes this 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 around 65 basis points…

(Article source: Cailian Press)