Markets shift back towards potential Fed rate cut this year with Iran ceasefire in place

Investors are evaluating the possibility of a rate cut by the end of the year after the USA and Iran reached an agreement on a ceasefire.

The odds of a cut rose Wednesday morning, reaching nearly 43%, according to CME Group’s report. FedWatch Tool that uses 30-day federal funds futures contracts to calculate market expectations for the Federal Reserve’s actions.

Market pricing implies a rate of 3.5% for the overnight borrowing benchmark in December, compared to the current effective level of 3.64%.

Before the announcement, the market implied chance of disruption was only 14%.

Investors had expected the Fed to hesitate to cut rates this year as the Iran conflict sent energy prices soaring and threatened the central bank’s efforts to return inflation to its 2% target. Before that, markets had expected multiple cuts this year to shore up the struggling labor market.

With peace in Iran remaining fragile to say the least, perceptions have begun to shift towards the possibility of disruption.

“The market is now giving a clear tilt to the Fed’s only cut this year,” Krishna Guha, head of global policy and central bank strategy at Evercore ISI, said in a note. “Assuming a possibly flawed deal is reached, this repricing is still a long way off and the impending inflation shock is now much less likely to threaten inflation expectations.”

Guha sees interest rate cuts for the Fed’s global counterparts, including the Bank of England, the European Central Bank and the Bank of Japan.

Markets in the US will receive data this week that will provide two perspectives on inflation.

The Commerce Department on Thursday will release the personal consumption expenditures price index, the Fed’s preferred gauge that shows where inflation was in February ahead of the Middle East war. Then on Friday, the Bureau of Labor Statistics will release the consumer price index for March, which will reflect the price impact of hostilities.

Economists expect the PCE report to show headline inflation at 3% and core inflation, which excludes food and energy, at 2.8%, according to the Dow Jones consensus. The corresponding readings for CPI for March were pegged at 3.3% and 2.7%; The level of all items reflects energy price increases caused by the war.

Guha emphasized that the chances of a permanent peace with Iran are still variable and said he expects generally cautious tones from policymakers in the coming months.

“Then, provided the incoming information is reassuring, it will potentially turn to a more dovish outlook from the end of the summer and fall within the scope of one, possibly two, cuts during the year,” he said.