Fed rate cut betting revived, in a small way, by the ceasefire in the Iran war

Federal Reserve policymakers could consider lowering interest rates this year, now that the?announcement of a two-week pause in the Iran conflict?has eased fears about a resurgence of inflation. However, with the uncertainty surrounding the prospects for peace, and oil prices 30% higher than their prewar level, it is still far from certain.

On Wednesday, traders bet on the possible impact of a lasting Middle East settlement and the reopening of Strait of Hormuz for shipping.

Israeli airstrikes in Lebanon and an Iranian attack on a Saudi Arabian pipeline have raised uncertainty about the temporary truce. Minutes from the Fed meeting of March showed that some central bankers were willing to raise rates if inflation remained high.

The data expected this week is likely to show that consumer prices rose in March at an unprecedented pace, not seen since 2022 when post-pandemic inflation peaked and triggered a round of aggressive Fed rate increases.

Fed policymakers have said that a temporary spike in headline prices would not warrant a change in short-term rates. However, a longer-lasting conflict and higher prices which could affect household finances could force policymakers to make a tough choice. They could either keep rates high in order to combat inflation, or reduce rates to cushion the economy.

As a U.S. peace delegation was heading to Pakistan this weekend for talks, traders hedged their bets.

Interest rate futures contracts reflect a 1 in 4 chance that the U.S. will cut interest rates by year's end. This is down from a 65% probability of a rate reduction priced immediately following the ceasefire. However, it's also a big shift from the time before the ceasefire when traders had already built in some chances of a Fed interest rate hike.

Evercore ISI's Krishna Guha wrote: "With conditions less likely to force the Fed to raise this year, we believe the market should be pricing closer to a full cut in the U.S.,"

The'shift in expectations of central banks after the ceasefire announcement is more apparent elsewhere - traders are reducing their bets that multiple rate increases by the European Central Bank and the Bank of England would occur.

Mary Daly of the San Francisco Fed did not dwell on the implications of a ceasefire for interest rate policy when she spoke Wednesday.

She told the St. George Area Chamber of Commerce that it is too early to tell how the 'Iran War and higher oil prices will affect the economy, because it depends how long the conflict lasts.

She said, "There is a concern this may push inflation higher: it's our responsibility to focus on that." "There's concern that the labor market might not be as solid. But we don't see that. We're just seeing it settle in a good spot." (Reporting and editing by Andrea Ricci)

(source: Reuters)