US Fed policy rate outlook flips from cuts to hikes by year-end

As international oil prices have surged on the fallout from the U.S.-Iran war, stoking concerns over inflation (rising prices), expectations that the U.S. central bank (Fed) could raise its policy rate this year are gaining more traction than forecasts for cuts. Until recently, financial markets had been expecting the Fed’s rate-cut cycle to continue this year, expanding liquidity.

According to CME Group’s FedWatch Tool on the 20th (local time), after the regular Federal Open Market Committee (FOMC) meeting scheduled for December 9, the most likely outcome—at 63.2%—was that the U.S. policy rate would remain at its current range (3.5–3.75%).

The second-most likely rate range was 3.75–4%, up 0.25% point from the current level. In other words, the likelihood of a year-end rate hike has increased relative to the likelihood of a cut.

A week earlier (March 13), the highest-probability outcome after the December FOMC meeting was a rate range of 3.25–3.5%, down 0.25% point from now, at 40.3%. A month earlier (February 20), the highest probability—33.2%—was for a 0.5% point decline, and the combined probability that the policy rate would be lower than now totaled 94.3%.

As the policy-rate outlook shifted from cuts toward hikes, short-term rates jumped. On the day, the yield on the U.S. 2-year Treasury rose intraday to the 3.9% range. The 2-year Treasury yield had been around 3.4% just before the outbreak of the Middle East war, but surged by about 0.5% point in the three weeks after hostilities began.

The driver was the spike in international oil prices stemming from the U.S.-Iran war. With Iran—at a relative military disadvantage—responding by moving to block the Strait of Hormuz, a key global crude shipping route, oil prices climbed to the point of swinging above and below $100 a barrel. If these conditions persist, inflation will inevitably face sustained upward pressure, creating an environment in which central banks have little choice but to move toward tighter policy.

Han Kyung-woo, Hankyung.com reporter case@hankyung.com