Ceasefire agreement boosts expectations of interest rate cuts, Fed's Powell downplays market speculation.

The ceasefire in Iran has slightly raised market expectations for a rate cut by the Federal Reserve. However, San Francisco Fed President Daly stated on Wednesday that despite the Iran war causing a significant increase in oil prices and the uncertain duration of the war, the fundamentals of the U.S. economy remain "strong"; indicating that she is not in a rush to ease policy. Daly said, "What we are seeing is that consumers are still spending, and businesses are still investing. Some are worried that this may push up inflation: that's our job, we will be watching that closely. And some are concerned that the labor market may not be stable enough, but we are not seeing that, we see it in a pretty stable state." The two-week ceasefire agreement reached on Wednesday in Iran has boosted hopes for a long-term reconciliation and led to a drop in oil prices. Previously, traders had started anticipating a rate hike by the Federal Reserve to address inflation caused by the oil crisis, and now they are considering the possibility of a rate cut by the Federal Reserve this year. With the temporary two-week ceasefire agreement in the Iran conflict easing concerns about a return of inflation, Federal Reserve policymakers may consider a rate cut later this year. However, due to the uncertain peace prospects and oil prices still about 30% higher than before the war, loose monetary policy is far from certain. At least that's how traders bet on Wednesday, digesting the potential impacts of a long-lasting peace agreement in the Middle East and the reopening of the Strait of Hormuz. Meanwhile, Israeli airstrikes in Lebanon and the Iranian attack on a Saudi oil pipeline highlight the uncertainty of the temporary ceasefire. The minutes of the Federal Reserve's March meeting show that some central bank officials feel it necessary to indicate that they will consider a rate hike if inflation remains high. Data expected to be released later this week may show that the rate of consumer price increases in March is the highest since the peak inflation following the pandemic in 2022, which triggered a round of aggressive rate hikes by the Federal Reserve. Federal Reserve policymakers have stated that a temporary spike in inflation is not enough to prompt them to adjust short-term rates. However, if the war lasts longer and prices continue to rise, potentially damaging household finances, they may face a difficult choice: whether to maintain high rates to address inflation or to cushion economic pressures by lowering rates. Daly does not seem to have any hope for a rate cut. She believes that the labor market is stable, indicating that she is not in a rush to ease monetary policy; and she has pledged that the Federal Reserve will focus on controlling inflation, which seems to point in the opposite direction. She did not directly address her views on the appropriate rate path. When Daly spoke on Wednesday, she did not talk much about the impact of the ceasefire on interest rate policy. Instead, she told the St. George Area Chamber of Commerce in Utah that it is too early to judge how the Iran war and rising oil prices will affect the economy, as it depends on the duration of the conflict. "I think the fundamentals of the economy are indeed good," Daly said. "The question is how will the war develop? How long will oil and gas prices remain high? And... what knock-on effects will there be on other goods and services?" Daly said it is too early to know the answers to these questions, as it depends on the duration of the conflict. "What's important is that we know the fundamentals of the economy remain strong, and those are critically important for how we think about the longer-term development of inflation and labor market developments," she added. As the U.S. delegation is set to engage in peace talks in Pakistan this weekend, traders are hedging their bets. Current interest rate futures contracts reflect a one-in-four likelihood of a rate cut by the end of the year. This is lower than the approximately 65% chance of a rate cut immediately priced in after the ceasefire agreement took effect, but there has been a significant change from before the ceasefire agreement, when traders had already factored in the possibility of a rate hike by the Federal Reserve. "Given the unlikely scenario of forcing the Federal Reserve to hike rates this year, we believe the market should fully price in the expectation of a one-time rate cut," wrote Krishna Guha of Evercore ISI. Following the ceasefire declaration, central bank expectations in other parts of the world have markedly shifted, with traders reducing their bets on multiple rate hikes by the European Central Bank and the Bank of England.