Rising oil prices impact interest rate cut expectations, U.S. Treasury traders' expectations for the Federal Reserve not to cut rates this year heat up

U.S. Treasury options traders are increasingly betting that the Federal Reserve may not cut interest rates at all this year. The reason is the escalating conflict in the Middle East, which has driven up oil prices and could further elevate inflation. According to data compiled by the Atlanta Federal Reserve, as of Wednesday, traders expect a 25% probability that the Fed will maintain its current interest rate range through December. This is up from 17% last Friday, which was the last trading day before the outbreak of the Iran war. Among all possible scenarios, "no rate cuts for the year" has become the single most probable outcome. Other scenarios include a 24% probability of a single 25 basis point cut and a 12% probability of two cuts. Meanwhile, traders even anticipate a 16% probability of a rate hike, up from 8% last Friday. These figures are derived from calculations based on secured overnight financing rate (SOFR) futures options, which are linked to the Fed's policy rate. Industry insiders say, "When oil prices soar, the impact on inflation must be considered. This pushes inflation upward, thereby reducing the likelihood of the Fed cutting rates." Of course, when considering all scenarios, the overall probability still leans towards a rate cut. However, the latest pricing changes indicate that as oil prices have risen nearly 20% this week, traders' confidence in the Fed's ability to actually lower borrowing costs this year has significantly decreased. The flow of options trading over the past few days also shows a sustained increase in the market's demand for hedging against the risks of the Fed reducing easing or even not cutting rates. Another tool used to bet on the Fed's policy path—the interest rate swap market—also reflects that the Fed's stance has become less dovish. Traders currently expect cumulative rate cuts of about 35 basis points by the end of the year, down from an expectation of about 60 basis points last weekend. The cooling of rate cut expectations has triggered a recent sell-off in U.S. Treasuries, pushing yields to several-week highs. This marks a reversal from the strong rally in Treasuries seen in February, when investors heavily bought U.S. Treasuries as a safe haven due to concerns over the potential impacts of artificial intelligence and cracks in the private credit market