Oil prices surge—why does Bank of America still expect the Fed to cut rates twice this year?

Despite the sharp rise in oil prices and sudden intensification of inflation pressure driven by the Iran war, Bank of America still maintains its forecast that the Federal Reserve will cut interest rates twice this year—each by 25 basis points in September and October, totaling a 50 basis points reduction for the year.

Bank of America admits that, if calculated using the Taylor Rule for its current forecast, the conclusion would point to raising rates or keeping them unchanged. The current rate cut prediction is based on three non-economic logics: the Fed tends to overlook supply shocks, downside risks in the labor market are still given attention, and there is pressure from political factors.

However, the risk list cannot be ignored: if inflation continues to rise unexpectedly, the war drags on longer than expected, inflation expectations begin to systematically climb, or wage inflation rebounds, the Fed may opt to take no action at all. Bank of America admits, “Our forecast foundation is not solid, and the risk is skewed toward no rate cuts this year.”

Supply-side Shock Returns: Fed’s Habit Is “Looking Through”

According to Wind Trading Desk, Bank of America economists point out that the Iran war poses another round of supply-driven stagflation shock to the US economy, following the Russia-Ukraine war and last year’s tariff policies, once again putting the Fed’s dual mandate—employment and inflation—into a dilemma. The risks of rising inflation and increasing unemployment rate are intensifying simultaneously.

Nevertheless, the Fed has always tended to “look through” such supply-side shocks rather than immediately tighten monetary policy, with a policy bias still pointing to rate cuts. This stance was evident in the March economic forecast: out of 19 participants, 12 still expect at least one rate cut this year.

Bank of America believes the recent ceasefire agreement—despite its fragility—makes it more confident in its baseline forecast that the war will end before the end of the month.

If the war can end this month, the transmission of rising oil prices to core inflation will be limited, inflation expectations will remain anchored, and the Fed will be able to downplay higher overall inflation data in the coming months.

Labor Market: Stable, Not Overheated; Downside Risks Remain

The March FOMC meeting minutes show that "the vast majority of participants believe the risk to employment is tilted to the downside," and many participants view the labor market as "vulnerable to adverse shocks."

Bank of America believes the Fed’s reaction function still places more weight on downside risks in the labor market.

The March employment report was strong overall—non-farm payrolls added 178,000 (expectation was only 65,000), unemployment rate fell to 4.3%—but Bank of America points out that soft indicators remain: March U-6 unemployment rate rose slightly, median unemployment duration lengthened; February JOLTS report showed sluggish hiring and limited job openings.

The more crucial structural change is that the “heat” of the labor market is far less than in 2022: the ratio of job openings to unemployed has fallen from a high of around 2.0 in 2022 to below 1.0, indicating a significant excess capacity in the labor market.

Currently, the market is in a “low firing, low hiring” cool phase, not a 2022-style overheated cycle. Bank of America also warns that in keeping with the patterns of summer 2024 and 2025, this summer may see a further weakening in non-farm employment and increased layoffs, setting the stage for September rate cuts as in the previous two years.

Limited Wage Inflation Pressure: Powell’s “Labor Market Not a Source of Inflation” View Supported by Data

Powell stated clearly at the March press conference: “The labor market is clearly not a source of inflationary pressure.”

Bank of America’s data supports this: average hourly earnings for non-management and production workers rose only 3.4% year-on-year in March, with annualized quarterly growth at 3.1%. Productivity improvements in recent years have also sharply reduced unit labor costs, with growth far below 2022 levels.

Thus, Bank of America believes that current inflation mainly comes from external supply shocks in energy, not cost-push inflation from labor market overheating, providing theoretical support for the Fed's focus on managing downside risks.

Political Pressure Not to Be Underestimated: Walsh’s Appointment Is a Key Variable

Bank of America explicitly lists “political factors” as the third pillar supporting its rate cut forecast.

The Senate Banking Committee has scheduled Walsh’s Fed Chairman nomination hearing for April 16. Though Senator Tillis (Republican, North Carolina) said he will not vote to confirm Walsh before the Justice Department’s investigation of Powell concludes, Bank of America still expects Walsh to formally take office no later than before the September meeting.

Once Walsh takes over the Fed, he will be able to steer policy options toward the dovish direction at each meeting.

Assuming the Iran war is resolved soon and tariff effects gradually fade to improve month-on-month inflation data, seasonal labor market weakness in the summer will support his dovish arguments, helping win enough votes for rate cuts to be realized this year.

However, Bank of America also cautions about another historical aspect: In April 2008, Walsh publicly expressed concern about rising commodity prices, saying “You can’t wait until inflation expectations are out of control to act, since by then it’s already too late.” This history suggests Walsh’s policy may not be as dovish as expected, especially under persistent inflation pressure.

Growth Forecast Lowered: Q1 GDP Tracking Down to 1.9%

On economic growth, Bank of America has lowered its Q1 GDP tracking estimate from 2.2% to 1.9% (quarter-on-quarter annualized), dragged down mainly by weaker-than-expected and revised down February control group retail sales, lower-than-expected January business inventory, and lower-than-expected February personal income and expenditures. Meanwhile, the final value for Q4 2025 is confirmed at 0.5%, matching Bank of America’s previous expectation.

For the whole year, Bank of America has lowered its 2026 GDP forecast, projecting a 4Q/4Q growth of 2.2% and an annual average of 2.3%. Early signs of cooling are seen in consumption: February real personal expenditures increased only 0.1% month-on-month, with annualized growth over the past three months dropping to 0.8%. Meanwhile, the overall PCE's three-month annualized growth rose to 4.1% in February; further rises in energy prices are expected to continue constraining real consumption in the near term.

Inflation: Peak Expected in Q2, Running Above Fed Target Throughout

Energy price shocks have significantly worsened the inflation outlook.

Bank of America expects overall PCE inflation to peak at 3.8% in Q2 of 2026, 70 basis points higher than previous forecasts, then quickly decline as oil prices fall. But even with sinking oil prices, the overall price level at the end of 2027 will still be 30 basis points higher than before, reflecting the impact of rising food inflation and ongoing supply chain problems worldwide.

For core inflation, energy price increases will transmit to core inflation with a lag. Bank of America expects Q4/Q4 core PCE in 2026 to be 3.1% (previously 2.8%), possibly falling to 2.5% in 2027. Overall, inflation will persist above the Fed’s 2% target throughout the forecast period.

Consumer Data Still Resilient, But Structure Is Distinctly Divergent

Despite macroeconomic pressure, internal BofA credit and debit card data shows total household card spending growth reached 6.5% year-on-year for the week ending April 4, noticeably accelerating from the week prior.

Of this, oil and gas spending surged 20.9% year-on-year, directly reflecting how oil price shocks have distorted consumption structure; entertainment spending grew 14.7%, groceries 10.5%, online retail 11.0%, showing that consumer demand still has some support. In contrast, categories like furniture, home renovation, and department stores declined year-on-year, highlighting pronounced differentiation in consumption structure.

For investors, the current core logic is: the Fed's dovish bias has not reversed, but uncertainty from inflation shocks is testing the boundaries of this stance. Whether there will be a rate cut in September depends largely on the durability of the ceasefire, the trajectory of inflation expectations, and policy signals after Walsh takes office—these three variables will be the most critical indicators worthy of close observation in the coming months.

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The above highlight is from Wind Trading Desk.

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