As traders bet on Fed rate hikes, analysts take the opposite view: at least one rate cut this year, possibly as early as September!

The Federal Reserve faces a dilemma amid the Middle East war shock—economists and market traders have markedly different views on the outlook for interest rates.

According to a Reuters survey of 82 economists conducted from March 20 to 25, nearly three-quarters of respondents expect the Federal Reserve will not cut rates before at least September this year, but most still maintain a baseline forecast of at least one rate cut within the year.

Meanwhile, market traders are significantly increasing bets on Fed rate hikes; implied probabilities in the swap market now exceed 50% for a hike this year, and the gap between economists and the market continues to widen.

The US and Israel's war with Iran has entered its fourth week, international oil prices have surged over 40%, and inflationary pressures have sharply risen. The Fed last week kept its benchmark rate unchanged at 3.50% to 3.75%. Several officials subsequently signaled that inflation risks are now the top priority, making the likelihood of rate cuts in the short term extremely limited.

Economists: Rate cut window delayed to September, but still possible this year

The Reuters survey shows out of 82 economists polled, 61 expect the Fed to hold rates in the next quarter, whereas two weeks ago about two-thirds still expected a cut to a 3.25%-3.50% range by the end of June. 55 economists believe the first rate cut will not occur until at least September.

Jonathan Millar, Senior US Economist at Barclays, said, "The Federal Reserve will need more time to be confident that inflation is returning to a path consistent with its 2% target; we don't see this happening before September." He also pointed out, "It is entirely possible that the Fed will wait longer to observe oil price trends, pushing rate cuts back until next year."

Regarding the end-of-year interest rate outlook, the opinions of economists are divided: 37 expect two rate cuts, 28 expect one, 13 expect rates to remain unchanged for the year, and 4 expect three cuts. The median of the Fed's FOMC dot plot last week suggested one rate cut this year. Among the 75 economists who participated both in the latest survey and in the poll before the March 17–18 policy meeting, about 45% have pushed back their expected timing for rate cuts.

Market betting on rate hikes rises, Treasury curve bear-flattens

In contrast to the relatively restrained stance of economists, market traders are reacting much more aggressively. According to Bloomberg, with rising oil prices and contradictory messages regarding Iran ceasefire negotiations, traders continue to ramp up bets on Fed rate hikes, and the US Treasury yield curve is showing a bear-flattening trend.

Swap markets now imply a 13-basis-point Fed rate hike before October, with traders generally seeing this as the peak of the current hiking cycle; as of Wednesday, this figure was only 8 basis points. Tightening priced in before December is at 11 basis points. Financial markets have largely ruled out any rate cuts this year, placing the probability of a hike near 30%.

The yield on the US 2-year Treasury has risen more than 55 basis points since before the war, and financial conditions have tightened spontaneously—without the Fed raising the federal funds rate. Jonathan Millar commented, "I don’t think this is a case of financial markets truly guiding the Fed," emphasizing that the tightening of financial conditions is acting independently.

Inflation expectations rise sharply, new Fed Chair faces pressure

Economists have recently significantly raised their inflation forecasts, mainly focusing on overall inflation indicators.

The Reuters survey shows that the Fed's preferred inflation index, Personal Consumption Expenditures (PCE) price index, is expected to rise 3.3%, 3.1%, and 2.9% year-on-year in the second, third and fourth quarters of this year respectively, universally revised up by about 50 basis points from the forecasts two weeks ago, and all higher than the Fed’s latest official projections. Notably, prior to the outbreak of war, US inflation was already about one percentage point above the Fed’s 2% target.

On the political front, Trump has nominated Kevin Warsh as the next Fed Chair, repeatedly criticizing current Chair Powell for being too slow in cutting rates.

Jan Groen, Chief US Economist at Societe Generale, remarked, "Any Chair coming in who demands aggressive rate cuts will find it very difficult to reach consensus in the committee, at least this year." He also stressed, "All factors related to the Iran war and its impact on the oil market are exacerbating inflation concerns."

Risk Warning and DisclaimerThe market has risks, investment must be cautious. This article does not constitute personal investment advice and does not take into account individual users' specific investment goals, financial situation or needs. Users should consider whether any opinions, viewpoints, or conclusions in this article fit their particular circumstances. Investing accordingly is at your own risk.