Will there be no interest rate cuts before 2027? To the Federal Reserve (Fed)

The military operations in the Middle East since Saturday, February 28 have disrupted monetary policy expectations. The longer they last, the stronger the impact on future monetary policy.

However, the forecast for the end of February is quite optimistic. The U.S. inflation rate has just fallen to 2.4% (measured by CPI), the spot inflation rate is low, and the market is expected to cut the U.S. federal funds rate at the June monetary policy meeting, and Kevin Warsh will take over as chairman of the Federal Reserve. It was expected to benefit from a favorable price environment, but due to the conflict in the Middle East, everything has been called into question.

The impact on oil and gas prices has been significant due to the closure of the Strait of Hormuz and military strikes targeting oil and gas facilities around the Persian Gulf.

Clearly, higher energy prices will push up nominal inflation, at least in the short term. However, there is one major uncertainty: time. About a month later, oil prices remained above $90 (here based on US crude oil), and the effect became evident in short-term inflation. If high energy prices persist for more than three months, the impact will become more structural and extend to the prices of many goods and services. However, nothing is certain: downward pressure on prices could also emerge if geopolitical tensions significantly slow global economic growth. But for now, the focus remains on rising energy prices due to geopolitical factors.

Is it still possible that the Fed will cut interest rates this summer under Kevin Warsh? Yes, but only if the geopolitical and energy situation around the Persian Gulf and Strait of Hormuz returns to normal by the end of April.

Multiple indicators indicate that the market currently does not expect the Federal Reserve to cut interest rates before 2027. Of course, this situation can develop quickly:

• The trend in the two-year Treasury yield is considered the best predictor of Fed policy. Two-year Treasury yields have recently risen above the Fed’s current interest rate, broadly signaling that markets don’t expect a rate cut, or even a rate hike, to counter a rebound in inflation.

• CME Group’s FedWatch tool, based on U.S. federal funds rate futures contracts traded in Chicago, shows institutional investors don’t expect any rate cuts before mid-2027

The chart below shows CME Group’s FedWatch tool that the market is not expecting a rate cut until the end of 2027:

The chart below shows the daily Japanese candlestick for the 2-year U.S. Treasury yield:

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