Markets reprice Fed cut odds following Iran ceasefire deal

Traders have begun factoring in the possibility of an interest rate cut by the end of the year following a ceasefire agreement between the United States and Iran.

According to data from CME Group’s FedWatch tool, the probability of a rate reduction rose to approximately 43% on Wednesday morning.

The FedWatch, which calculates expectations using 30-day fed funds futures contracts, showed a notable jump from just 14% before the ceasefire announcement.

Market pricing now implies that the benchmark overnight borrowing rate could fall to around 3.5% by December, compared with the current effective rate of 3.64%.

Shift in sentiment driven by energy and inflation outlook

Before the ceasefire, expectations for rate cuts had been suppressed.

The conflict with Iran had pushed energy prices higher, raising concerns that inflationary pressures could derail the Federal Reserve’s efforts to bring inflation back to its 2% target.

Earlier in the year, markets had anticipated multiple rate cuts as policymakers sought to support a slowing labour market.

However, escalating geopolitical tensions and rising oil prices had tempered those expectations, leading traders to assume the Fed would remain cautious.

With the ceasefire now in place, even if fragile, sentiment has shifted back towards easing monetary policy.

Analysts see scope for further repricing

Krishna Guha, head of global policy and central bank strategy at Evercore ISI, noted that markets are increasingly leaning towards at least one rate cut this year.

“The market is now discounting a clear skew to one cut from the Fed this year,” Guha said in a note.

Krishna also added, “Assuming a flawed deal likely will be reached, this repricing has more to go, with the looming inflation shock now much less likely to threaten inflation expectations.”

Guha also suggested that easing could extend beyond the United States, with potential rate cuts from global counterparts, including the Bank of England, European Central Bank, and Bank of Japan.

Investors are now turning their attention to upcoming economic data releases, which are expected to provide further insight into inflation trends.

The Commerce Department is set to release the PCE price index on Thursday.

The report will reflect price levels in February, before the onset of Middle East hostilities.

This will be followed by March’s consumer price index (CPI) data from the Bureau of Labor Statistics on Friday, which is expected to capture the impact of rising energy prices during the conflict.

Economists surveyed by Dow Jones expect headline PCE inflation to come in at 3%, with core inflation at 2.8%.

For CPI, projections stand at 3.3% for headline inflation and 2.7%, with energy price increases likely influencing the overall reading.

Outlook remains cautious despite optimism

Despite the improved outlook, Guha cautioned that the situation remains uncertain, particularly regarding the durability of the ceasefire agreement.

He indicated that policymakers are likely to maintain a cautious stance in the near term, closely monitoring incoming data and geopolitical developments.

“Then, provided that incoming information is reassuring, will shift back more dovish potentially from the late summer onwards, with scope for one, possibly two cuts later in the year,” Guha said.

For now, markets appear to be recalibrating expectations, balancing easing inflation risks against lingering geopolitical uncertainty.