The Federal Reserve is increasingly unlikely to cut interest rates this year as high inflation driven by the Iran war has altered market expectations. Before the conflict began on February 28, markets were pricing in around 50 basis points of easing by year end. However, headline annual inflation near 4%—double the Fed's target—and a resilient labor market have led traders and economists to reassess their forecasts.
Key Takeaways
The Federal Reserve is increasingly unlikely to cut interest rates this year due to high inflation driven by the Iran war. Traders now price in an 87.4% probability of no policy easing in September.
- Markets initially expected rate cuts but shifted due to persistent inflation and a resilient labor market
- UBS pushed back its forecast for rate cuts, citing elevated oil prices and strong job growth
- Some economists predict potential rate reductions despite the consensus for holding rates steady
Traders now price in a roughly 87.4% probability that the Fed will hold rates steady through September, according to CME's FedWatch tool as reported by Reuters. This shift comes amid elevated inflation risks and cautious policymakers. The Fed held rates steady at its April meeting in an unusually divisive vote, with three officials objecting to the easing bias.
UBS Global Wealth Management joined a wave of brokerages in pushing back their U.S. monetary policy easing forecasts, citing persistent inflation and resilience in the labor market and economic growth. The Iran war, which has stretched into its 11th week with no clear path to a ceasefire, has driven oil prices higher, heightening inflation concerns.
U.S. consumer inflation quickened to a three-year high in April, with energy inflation accounting for more than 40% of the rise. The wealth management division of UBS Bank expects the Federal Reserve to cut rates by 25 basis points each in December 2026 and March 2027. The brokerage had previously forecast 25 bps rate cuts in September and December this year.
Despite the consensus for no cuts, some economists remain optimistic about potential rate reductions. Citi and MUFG economists argue that the economy and labor market are weaker than they appear, predicting 75 basis points and 50 basis points of cuts respectively. They point to a fragile labor market marked by low demand for workers as reasons for their out-of-consensus calls.
The incoming Fed Chair, Kevin Warsh, who has advocated for lower rates, faces an uphill battle in convincing his colleagues to ease policy. Mark Zandi of Moody's Analytics suggested that Warsh may struggle to gain support for cutting interest rates given the current inflation environment. The market pricing around noon Tuesday implied about a 37% probability of a rate increase before the end of the year.
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