Markets shift back toward potential Fed rate cut this year with Iran ceasefire in place

Traders are closely monitoring the possibility of an interest rate cut by the end of the year following the ceasefire agreement between the U.S. and Iran. The odds for a rate reduction saw a significant increase on Wednesday morning, reaching around 43%, according to the CME Group’s FedWatch tool. Market pricing is now suggesting a 3.5% rate in December for the overnight borrowing benchmark, compared to the current effective level of 3.64%. Prior to the announcement, the market-implied odds for a cut were only at 14%.

Initially, traders were skeptical about a rate cut this year due to the surge in energy prices caused by the Iran conflict, which posed a threat to the Federal Reserve’s efforts to reach its 2% inflation target. However, with the prospect of a fragile peace in Iran, sentiment has shifted back towards the likelihood of a rate cut.

Krishna Guha, head of global policy and central bank strategy at Evercore ISI, noted that the market is now pricing in a clear bias towards one rate cut by the Fed this year. He also mentioned that rate cuts could be on the table for other central banks like the Bank of England, European Central Bank, and Bank of Japan.

In the upcoming week, the U.S. markets will receive data that will offer insights into inflation. The Commerce Department is set to release the personal consumption expenditures price index, the Fed’s preferred inflation gauge, which will indicate the inflation levels in February before the Middle East conflict. Additionally, the Bureau of Labor Statistics will release the consumer price index for March, reflecting the impact of the hostilities on prices.

Economists are expecting the PCE report to show headline inflation at 3% and core inflation at 2.8%. For the CPI report, the readings for March are estimated to be 3.3% for headline inflation and 2.7% for core inflation. Guha emphasized that the chances of a lasting peace with Iran are still uncertain, and policymakers are likely to maintain a cautious approach in the coming months.

Citigroup stands out in the market expectations, with their economists suggesting the potential for three rate cuts starting in September if oil prices continue to decline and inflation remains subdued.

Overall, the market dynamics are evolving rapidly in response to geopolitical developments, and traders are closely watching for any signals from central banks regarding potential rate cuts in the near future.