When oil prices surge, the interest rate market puts &#34;rate hikes&#34; back on the table. Citigroup believes that energy prices do push inflation risks up and growth risks down, but what is more likely to change is &#34;when to cut rates and by how much,&#34; rather than pushing the Federal Reserve back onto the rate hike track.
According to the Wind Trading Desk, Andrew Hollenhorst, an analyst from Citigroup's U.S. economic team, stated in a recent report that rate hikes are unlikely... Rate cuts may be delayed due to inflation concerns, but tighter financial conditions and higher energy costs will ultimately soften the labor market, leading to faster and/or deeper rate cuts.&#34; This sentence almost sets the framework for the entire text: In the short term, driven by oil prices, it ultimately returns to the constraints of employment and growth.
In their baseline scenario, energy prices are expected to retreat in the coming months, with the main change in macro forecasts being that gasoline prices in March-April will push &#34;overall inflation&#34; up; the trouble with core inflation may first arise from airfares (jet fuel), but the more tricky issue is that if the shock prolongs, the transmission of core goods will narrow the window for rate cuts.
The biggest divergence between Citigroup and the Federal Reserve is not in the inflation point but in the reading of the labor market: officials interpret the stability of the unemployment rate as &#34;equilibrium employment growth approaching zero,&#34; while Citigroup believes this may be &#34;residual seasonality&#34; masking the loosening process—there has been a pattern of rising unemployment rates in spring and summer over the past two years. Adding to this, the increase in gasoline spending and tax refunds falling short of expectations may bring growth-side pressures earlier than the market currently accounts for.
<h2>The market is betting on rate hikes, but Citigroup is focused on the path of &#34;holding steady → more aggressive rate cuts&#34;</h2>
The report begins by stating a reality: as energy prices continue to rise and global central banks (including Powell) adopt hawkish language, the interest rate market has &#34;violently&#34; shifted pricing from rate cuts to the possibility of rate hikes.
Citigroup's rebuttal is not complicated: Even if oil prices remain high for a longer period, the Federal Reserve may not need to &#34;chase&#34; inflation with rate hikes. The more common combination is—due to inflation concerns, keeping rates higher for longer, but high rates + high energy costs will drag down economic activity and increase the downside risks to employment, subsequently forcing the Federal Reserve to cut rates faster and deeper at a later stage.
They place the &#34;possibility of rate hikes&#34; within a very narrow set of conditions: only when energy prices are high and core inflation appears likely to persist above 3%, might some officials advocate for rate hikes; but even so, the committee is more likely to choose to extend the hold rather than directly restart the rate hike cycle.
<h2>Oil prices first push up &#34;overall inflation,&#34; but the real constraint on rate cuts is the tail transmission of core goods</h2>
In Citigroup's baseline scenario, the shock is mainly focused on gasoline prices in March-April: Overall inflation will be passively elevated, and they have thus raised the year-end overall PCE by about 0.5 percentage points.
Regarding core inflation, Citigroup's current biggest concern is not &#34;energy directly entering the core,&#34; but rather the faster rise in jet fuel leading to higher airfare prices. The greater tail risk is: if the shock prolongs, core goods will show more significant transmission of energy costs, thereby pushing back the timing of weakening core goods inflation
Here they pointed out a detail: Powell mentioned at the press conference that even before the rise in oil prices, core goods inflation was becoming a potential challenge for resuming interest rate cuts. Citigroup further emphasized that the core goods increase measured by PCE seems more stubborn than CPI; they tend to believe that CPI is more reliable because PCE may be inflated by the abnormal surge in prices of &#34;computer software and accessories.&#34; The Federal Reserve's original key assumption was that the strong core goods were mainly due to the transmission of tariff costs, which would cool down around mid-year—if energy transmission drags the &#34;strong&#34; past mid-year, it would be easier to delay interest rate cuts.
<h2>The &#34;stability&#34; of the unemployment rate may not be good news: Citigroup bets on another rise in spring and summer</h2>
Citigroup acknowledged that their inflation forecast is not far from that of the Federal Reserve; however, their judgment on employment is clearly more cautious. Officials emphasized the stability of the unemployment rate, suggesting that the &#34;balanced employment growth rate&#34; may have dropped close to zero; Citigroup believes that this stability may be the result of &#34;residual seasonality&#34;—similar patterns have appeared in 2024 and 2025: the unemployment rate begins to rise in spring and summer.
This judgment directly affects policy projections: if the labor market is &#34;slowly loosening,&#34; it is harder to imagine the Federal Reserve raising interest rates due to rising oil prices; conversely, once energy prices fall and the unemployment rate rises within the year, the current &#34;cautious hold&#34; may quickly switch to an interest rate cut initiative.
They also added a &#34;buffer&#34;: Both Powell and Waller mentioned that long-term inflation expectations remain stable. Citigroup's understanding is that this stability itself may become a reason for &#34;not raising rates, or even cutting rates in the future&#34;—even in scenarios with higher energy and inflation.
<h2>Higher gasoline bills, fewer tax refunds: Growth pressure may first manifest in the second quarter</h2>
Citigroup provided an intuitive quantification: consumer spending on gasoline will increase by about 30%, as long as energy prices remain high, translating to an annualized increase of about $110 billion, or about $10 billion more per month. As a result, the actual GDP annualized growth rate in the second quarter may be dragged down by &#34;several tenths of a percentage point.&#34;
More subtly, the tax refunds that were originally seen by many economists and some officials as a consumption &#34;tailwind&#34; have not materialized. Compared to the market expectation that tax refunds related to the &#34;One Big Beautiful Bill Act (OBBBA)&#34; could increase by $100 billion to $150 billion, Citigroup sees the result closer to an increase of only about $30 billion to $40 billion (their own forecast is about $50 billion).
The report also acknowledges that high oil prices may lead to more oil and gas investments, thus offsetting some of the consumption weakness; however, as of now, the number of drilling rigs has not increased, suggesting that oil producers view this round of impact as &#34;short-term&#34; and have not initiated expansion.
<h2>Powell and Waller's &#34;hawkish&#34; stance is more about buying time than changing direction</h2>
Citigroup characterized the communication after this FOMC as: before the meeting, they felt the risk was more dovish, but Powell's wording was more hawkish than expected. On the surface, the SEP's &#34;dot plot&#34; still provides a median path for one 25bp rate cut this year, even though core and overall inflation forecasts have been revised upward; however, Powell's concerns about the labor market are not as severe as the market imagines, nor did he strongly refute the notion that &#34;higher inflation may limit rate cuts.&#34;
Waller's changes are more tangible: he did not vote against an immediate rate cut as some speculated, but instead chose &#34;caution&#34; in line with the consensus. He later explained that without rising oil prices, a reduction of 92,000 jobs in February would have been enough for him to support a 25bp rate cut; now he sees the energy increase as more likely to be &#34;more persistent,&#34; so he needs to wait and see. However, he also left a backdoor: if the labor market weakens or the energy increase proves not to be persistent, he is likely to return to a position supporting a rate cut.
In terms of policy path, Citigroup's baseline scenario remains &#34;a cumulative rate cut of 75bp this year.&#34; Their interest rate forecast shows: no change in April, followed by rate cuts of 25bp in June, July, and September, bringing the policy range down to 2.75%-3.0% by September, after which it will pause.
<h2>What to watch next week: Oil prices and officials' statements may influence pricing more than data</h2>
Citigroup reminds that the short-term market will still be driven by oil prices and geopolitical changes, which will cause the interest rate market pricing to continue to &#34;diverge sharply&#34; from their policy judgments. They expect some officials to make counter-statements regarding the market pricing of &#34;rate hikes this year,&#34; especially more dovish figures like Daly and Paulson; the statements from Vice Chair Jefferson, who is closer to the committee's middle position, are also worth paying close attention to.
On the data front, Citigroup expects the S&amp;P PMI to still show moderate expansion, but the manufacturing input price index may attract more attention due to the impact of oil prices; initial jobless claims remain low, and they expect a slight rebound; construction spending is expected to continue to grow slightly. However, the subtext of this weekly report is that these data points are more like background noise, and the real &#34;metronome&#34; is still energy prices and how the Federal Reserve tells its story

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Citigroup believes that the Federal Reserve will not be pushed back onto the rate hike track by energy prices; a more likely scenario is "staying put for longer → followed by faster and deeper rate cuts." Short-term gasoline bills are consuming consumption, tax refunds are below expectations, and the unemployment rate may rise again in spring and summer—growth pressures may arrive earlier than the market anticipates. Citigroup's baseline scenario remains "a cumulative rate cut of 75 basis points this year," with no action in April and rate cuts of 25 basis points in June, July, and September

- Citi's analysis indicates that rising energy prices will push inflation risks up while negatively impacting growth, but this may only alter the timing and magnitude of potential rate cuts, not prompt an increase in rates.  
- The report suggests that if fuel prices remain high, consumer spending on gasoline could increase by about 30%, potentially dampening GDP growth in the second quarter.  
- Citi anticipates that while high energy prices might spur some oil and gas investment, current market conditions indicate that producers view the situation as short-term, inhibiting significant production expansion.

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In the face of high oil price shocks, the Federal Reserve will not raise interest rates, but will "cut rates faster and more significantly"?