【Iran Crisis】 Oil prices rise, Fed's stance shifts hawkish? US Bank: Market may misjudge the situation, significant rate cut opportunities also exist

U.S. banks warn that investors betting on the Federal Reserve adopting a more hawkish stance due to rising oil prices may be misjudging the situation. The bank points out that supply shocks could also lead to unchanged or even significantly lower interest rates.

Since the outbreak of the Iran conflict, the yield on the two-year U.S. Treasury has tracked the surge in oil prices, reflecting market expectations of higher borrowing costs. However, U.S. bank economist Aditya Bhave believes this assessment may be incorrect.

Bhave notes that energy shocks do not necessarily mean a policy shift to hawkishness, as this could put the Fed in a dilemma between “stabilizing prices” and “supporting employment.” In a Tuesday (10th) article, he stated that this would “thicken the tail of policy distribution,” meaning the risk of long-term inaction increases, with both the tail risk of rate hikes and the risk of significant rate cuts intensifying.

Since the beginning of this month, short-term government bond yields have risen by about 20 basis points. Currently, traders expect the Fed to cut rates by approximately 40 basis points this year, less than the over 60 basis points anticipated before the conflict erupted.

Bhave further analyzes that the current market reaction is similar to the early stages of the Russia-Ukraine war in 2022, but the macroeconomic background has changed dramatically. At that time, U.S. unemployment was extremely low, and consumers held large amounts of government stimulus cash; by contrast, the labor market now shows signs of weakness, and fiscal support is more moderate. He emphasizes, “If the oil shock persists, it will lay the groundwork for the Fed to adopt a more dovish response.”