Market Trims Hawkish Scenario, Rate Cut Probability Rises Sharply
Market expectations for a Federal Reserve interest rate cut shifted rapidly after the US and Iran agreed to a two-week ceasefire. CME data showed the probability of at least one rate cut by December rose to 43% from 14% the day before. This change coincided with a decline in yields, as oil prices fell back below US$100/barrel, though still well above pre-war levels of around US$70/barrel.
This repricing is significant because throughout the war, the market shifted from a scenario of multiple cuts to even considering rate hikes due to energy shocks. The likelihood of a hike has now been priced out, but the market has not yet returned to its pre-war view of consecutive cuts, as uncertainty over the ceasefire remains high and normalization of global oil and gas flows could take months even if the Strait of Hormuz is reopened.
In terms of transmission, the oil decline mitigates the risk of energy inflation and reduces pressure on the Fed to maintain tight policy. However, "high-for-longer" remains the baseline if inflation persists. BofA, through economist Stephen Juneau, believes the Fed could consider a cut if the unemployment rate exceeds 4.5%. However, this threshold could be higher if inflationary risks from the conflict persist, especially when indicators such as job openings and the pace of hiring in the JOLTS data show weakness.
The current market baseline scenario tends to point to a one-off cut if oil continues to soften and inflation data eases, while the Fed awaits confirmation from the labor market. Alternatively, if de-escalation is fragile or the recovery of Hormuz flows is slow, putting pressure on energy prices again, the Fed could hold off on a longer cut. Conversely, a sharper labor market weakening could force a faster easing even if inflation remains subdued.
The market will be monitoring the implementation of the ceasefire, the smoothness of Hormuz flows and the timing of logistics recovery, the direction of Brent/WTI, the next inflation release, shifts in inflation expectations, as well as labor indicators (unemployment, JOLTS, wages) and communications from Fed officials.
Source: Newsmaker.id
