Energy price spike on Mideast war has traders betting on no Fed cuts through June

A war in the Middle East, and the resultant upward pressure on oil prices, has caused traders to reverse bets that the Federal Reserve will cut interest rates in the first half of this year.

The prediction market-implied odds of a rate cut in June are less than 45% on Tuesday morning. Last week, the odds of a rate cut in June were around 60%. This comes as US national average gasoline prices rose 3.7% on Monday, their biggest one-day jump since 2005, according to data from the American Automobile Association.

(Event contracts are offered through Robinhood Derivatives, LLC — probabilities referenced or sourced from KalshiEx LLC or ForecastEx LLC.)

In the short term, higher energy prices put upward pressure on inflation and downward pressure on economic activity. Higher gasoline prices reduce households’ ability to spend more on other discretionary goods and services.

Normally, Fed officials would want to “look through” the impact of higher energy prices as a temporary source of upward pressure on inflation that is not indicative of the underlying trend. That’s why energy (and food) prices are stripped out of core inflation. However, this time might be different:

• Inflation has run above the Federal Reserve’s target for a prolonged period.

• The central bank is a little scarred by the un-transitory and severe postpandemic inflation (which was meaningfully accelerated by Russia’s invasion of Ukraine).

• Monetary policymakers were already signaling that the stabilization in jobs data and previous cuts, which brought their policy rate closer to a neutral setting, meant the bar for additional easing was higher.

“I think the Fed will be reluctant to elevate growth over inflation risks right now,” wrote Neil Dutta, head of US economics at Renaissance Macro Research. “Cuts have been a close-call as it is; thus, it’s tough to look through inflation when you are coming off a period of high inflation.”