Strait of Hormuz reopens; will the Federal Reserve shift to a dovish stance and will the market reprice rate cuts?

```

Two major catalysts for disinflation are fermenting simultaneously, providing ample basis for Federal Reserve Chair Walsh to turn dovish at this week’s Federal Open Market Committee (FOMC) meeting.

According to “Chasing the Wind Trading Desk”, a report from Citi Research published on June 15 states that the planned reopening of the Strait of Hormuz will push oil prices lower, eliminating the upside risk of energy prices on inflation; meanwhile, last week’s core CPI data came in noticeably cool, with a month-over-month increase of just 0.21%.

The combined impact of these two developments further weakens the case for the Fed to maintain a hawkish stance, putting the prospect of rate cuts back on the agenda.

For the market, this judgment has direct pricing implications. The two-year U.S. Treasury yield has fallen about 13 basis points from a week ago, but is still over 60 basis points higher than in February. There is still room for the market’s pricing of rate hikes to be compressed, and further upside for the pricing of rate cuts.

Energy Price Pressure Eases, Inflationary Risks Diminish

The expectation of the Strait of Hormuz reopening is a core driver of this round of dovish logic. Once the strait reopens, increased crude oil supply will drive down oil and other energy prices.

Gasoline prices have been falling for a month straight, with the national average dropping from about $4.50 to $4.00 per gallon. Citi expects that other energy commodities will also decline further in the near future. This trend is expected to bring several months of negative headline inflation readings in the coming months, and is likely to prompt Fed officials to change their characterization of energy prices from an “inflation risk” to a “neutral or even deflationary factor.”

Core CPI Cools, Inflation Indicators Diverge Further

On the core inflation front, while May’s core PCE is still expected to remain strong, core CPI has already shown clear signs of cooling, with a month-over-month increase of only 0.21%.

Core PCE has become increasingly “atypical” among current inflation indicators—the trimmed mean PCE and core CPI are both closer to the target level and their downward trend is more apparent. This divergence is being recognized more and more widely by the market and Fed officials, providing data support for a dovish stance.

Hawkish FOMC Adjustment Fully Priced In, Room for More Dovish Signals

The report expects this week’s FOMC statement to remove its “easing bias” language and the median of the dot plot to show rates staying unchanged this year. However, these hawkish adjustments have already been fully expected by the market and do not amount to new incremental information.

The real variable is Walsh’s tone. Combined with the latest developments on the reopening of the Strait of Hormuz and the cooling trend of core inflation, the risk that Walsh sends a dovish signal at this meeting is tilted to the upside. If his remarks are more dovish than expected, the market’s repricing for the path of rate cuts may accelerate.

U.S. Treasury Yields Still Have Room to Fall, Market Pricing Can Adjust Further

From a market pricing perspective, the report believes that the implied probability for rate hikes in current interest rate futures remains high. The two-year U.S. Treasury yield has fallen about 13 basis points from a week ago, but is still more than 60 basis points higher than in February, indicating the market has not fully priced in the easing of inflation risk.

As the previously hawkish-supporting inflation risks dissipate, the market is expected to further compress rate hike pricing and simultaneously increase rate cut pricing. U.S. Treasury yields still have room to decline.

Risk Disclosure & DisclaimerThe market involves risks, and investment should be made cautiously. This article does not constitute individual investment advice, nor does it take into account the special investment objectives, financial situations, or needs of individual users. Users should assess whether any opinions, views, or conclusions in this article are applicable to their particular circumstances. Investing based on this is at your own risk. ```