The Federal Reserve faces a dilemma amid the shock of the Middle East war—economists and market traders have significantly divergent views on the interest rate outlook.
According to a Reuters survey of 82 economists from March 20 to 25, nearly three-quarters of respondents expect the Federal Reserve will not cut rates until at least September, but most still maintain a baseline expectation of at least one interest rate cut this year.
Meanwhile, market traders are substantially increasing their bets on Fed rate hikes, with the swap market currently implying a probability of more than 50% for a hike this year, as the expectation gap between economists and the market continues to widen.
The war between the United States and Israel against Iran has entered its fourth week, with international oil prices accumulating gains of over 40%, causing inflation pressure to surge suddenly. The Federal Reserve maintained its benchmark interest rate unchanged in the 3.50% to 3.75% range last week, and several officials subsequently signaled that inflation risks are the primary consideration, making a rate cut in the short term highly unlikely.
<h2>Economists: Rate Cut Window Postponed to September, But Still Room This Year</h2>
The Reuters survey shows that out of 82 surveyed economists, 61 expect the Federal Reserve to remain on hold next quarter, whereas just two weeks ago, about two-thirds of respondents anticipated a rate cut to the 3.25%-3.50% range by the end of June. Fifty-five economists believe the first interest rate cut will not occur until at least September.
Jonathan Millar, a senior US economist at Barclays, stated, &#34;The Fed will need more time to be convinced that inflation is on a path back to its 2% target, and we don't see this happening before September.&#34; He also pointed out, &#34;It is entirely possible that the Fed will wait and see how oil prices develop for a longer period, delaying interest-rate cuts until next year.&#34;
Regarding the year-end interest rate trajectory, economists' opinions are divided: 37 expect two interest-rate cuts, 28 expect one interest rate cut, 13 expect no change for the entire year, and 4 expect three interest-rate cuts. The median forecast from the Federal Open Market Committee's dot plot last week indicated one rate cut within the year. Among the 75 economists participating in the latest survey who also participated in the survey before the March 17-18 policy meeting, about 45% pushed back their rate cut expectations further.
<h2>Market Rate Hike Bets Rise, Yield Curve Bear Flattening</h2>
In contrast to the relative restraint shown by economists, market traders' reactions are more aggressive. According to Bloomberg, as oil prices rise and news related to Iran's ceasefire negotiations is mixed, traders continue to increase their bets on a Federal Reserve rate hike, and the US Treasury yield curve is showing a bear market flattening trend.
The swap market currently implies a 13-basis-point Fed rate hike before October, which traders widely believe will be the peak of this rate hike cycle; this figure was only 8 basis points on Wednesday. Pricing for tightening by 11 basis points by December. Financial markets have largely priced out the possibility of a rate cut this year and are pricing in a nearly 30% probability of a rate hike.
The US 2-year Treasury yield has risen by more than 55 basis points since before the war, and financial conditions have effectively tightened spontaneously without the Federal Reserve having to adjust the federal funds rate. Jonathan Millar commented on this, &#34;I don't think this is a situation where financial markets are truly guiding the Fed,&#34; and emphasized that the tightening of financial conditions is already acting independently.
<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/c60a7d5d-9641-49af-9ac6-a68229d8cc79.png?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="Image" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/c60a7d5d-9641-49af-9ac6-a68229d8cc79.png"/>
<h2>Inflation Expectations Sharply Revised Upward, New Fed Chair Faces Pressure</h2>
Economists have recently significantly revised their inflation forecasts upward, mainly focusing on overall inflation metrics.
The Reuters survey shows that the Federal Reserve's preferred inflation indicator, the Personal Consumption Expenditures (PCE) price index, is projected to increase year-on-year by 3.3%, 3.1%, and 2.9% in the second, third, and fourth quarters of this year, respectively. These forecasts are generally about 50 basis points higher than the predictions made two weeks prior and are all above the Federal Reserve's latest official forecasts. Notably, US inflation was already about one percentage point above the Federal Reserve's 2% target before the war broke out.
On the political front, Trump has nominated Kevin Warsh to be the next Federal Reserve Chairman and has repeatedly criticized current Chairman Powell for the slow pace of rate cuts.
Jan Groen, Chief US Economist at Societe Generale, stated, &#34;Any chairman who calls for significant interest-rate cuts upon taking office will find it difficult to build consensus within the committee this year.&#34; He also emphasized, &#34;All factors related to the war with Iran and its impact on oil markets are exacerbating concerns about inflation.&#34;

FNCL

The swap market currently implies a more than 50% probability of a rate hike this year. However, a Reuters survey of 82 economists shows that nearly three-quarters of respondents expect the Federal Reserve will not cut rates until at least September, though most still maintain a baseline expectation of at least one interest rate cut this year: 37 expect two cuts, 28 expect one cut, 13 expect no change for the year, and 4 expect three cuts

- The Federal Reserve faces a dilemma amid rising tensions in the Middle East, with economists and market traders drastically diverging on interest rate forecasts.  
- A Reuters survey indicates that nearly three-quarters of economists do not expect rate cuts until at least September, while traders are increasing bets on rate hikes, pushing implied probabilities beyond 50%.  
- The ongoing conflict and rising oil prices have heightened inflation concerns, prompting the Fed to maintain its current rate range, with varying expectations among economists regarding future rate changes by year-end.

Wallstreetcn

ISHRS Us Brokers & Sec Exchg

Fidelity MSCI Financials Index

VG Financial

S&P 500

Financial Select Sector SPDR Fund

Dow Jones Utility Average

Dow Jones Industrial Average

NASDAQ-100

JPMorgan Equity Premium Inc ETF

NASDAQ Composite Index

Dow Jones U.S. Index

As Traders Bet on Fed Rate Hikes, Analysts "Dissent": At Least One Interest Rate Cut This Year, As Early as September!