The market has little hope of a Fed rate cut this year. Oil prices are to blame

Traders in the bond market have lost confidence in even one interest rate cut this year by a quarter percentage point by the U.S. Federal Reserve, Bloomberg reported. The reason is the rise in oil prices, which reinforces inflation expectations.

Interest rate swaps tied to Fed meeting dates on Thursday, March 12, implied the Fed would ease monetary policy by only about 24 basis points by the end of 2026, Bloomberg writes. As late as late Wednesday night, the market was laying out a decline of about 30 basis points. And on February 28, at the beginning of the conflict in the Middle East, the markets laid at least 50 basis points of rate cuts - that is, two steps of 25 basis points, the agency notes.

"Concerns about the inflationary effect of rising oil prices have caused the market to cut expectations for Fed policy easing to one rate cut, and now even just under one," said John Briggs, head of U.S. rates at Natixis SA's investment banking unit. These fears only intensified after the cost of Brent crude exceeded the $100 per barrel mark for the first time since 2022 - after Iran closed the Strait of Hormuz, crucial for exports of raw materials from the Persian Gulf.

According to Briggs, the situation is different now than it was four years ago: the economic growth outlook is weaker, the labor market is softer and there is less fiscal stimulus, although the market does have "strong muscle memory."

The change in expectations comes amid a continued decline in prices of U.S. Treasury bonds, Bloomberg notes. The yield on two-year securities - more sensitive to Fed policy changes than long-term bonds - rose six basis points to 3.71%, the highest level since August, the agency reports. U.S. government bonds are under pressure this week as investors demand higher yields to compensate for the risk that a jump in oil prices caused by U.S. military action in the Middle East will lead to a new spike in inflation.

In mid-March, Morgan Stanley warned investors of the risk that the U.S. Federal Reserve could delay resuming interest rate cuts because of the surge in oil prices due to the war with Iran.

At the same time, the bank maintained its forecast for two rate cuts this year - in June and September by 0.25 percentage points each. However, the bank warned that the regulator could delay the first cut until September or even December, which would result in the next cut occurring as early as 2027.

This article was AI-translated and verified by a human editor