Middle East Conflict Shatters Rate Cut Dreams! Markets Begin Discussing Rate Hikes Deutsche Bank: Fed Will Avoid Repeating Past Mistakes

Caixin, March 24 — (Editor: Bian Chun) Investors originally expected the Federal Reserve to cut interest rates two to three times this year, but now they believe there may be no cuts at all. In fact, the market is already discussing the possibility of rate hikes.

According to the CME FedWatch Tool, the probability that the federal funds rate will remain at the current 3.5%-3.75% level through the December 2026 meeting is as high as 74%. In January, investors only saw a 5% chance of this outcome, when they expected at least a 50% likelihood of two to three rate cuts.

Meanwhile, traders are increasing their bets on rate hikes by the Fed, expecting a 20 basis point increase by the end of the year. On Monday, the swap market showed that the Fed would raise rates by 20 basis points this year, up from 8 basis points last Friday, and a week earlier, it indicated a 25 basis point cut.

This shift in expectations is mainly driven by soaring oil prices. After the US and Israel attacked Iran, Iran effectively blocked the Strait of Hormuz, disrupting global oil supplies and causing oil prices to surge.

On Monday, Brent crude oil prices fell slightly as US President Trump signaled a de-escalation, but since the outbreak of war, oil prices have still risen over 40%.

This upward trend has pushed up gasoline prices and raised concerns about broader inflation spikes. When the Fed worries that high inflation could outweigh the risks of a soft labor market, it tends to adopt a more hawkish stance, and investors are now factoring this into their pricing.

Chicago Fed President Goolsbee hinted at this on Monday. He said that with unemployment remaining relatively stable, inflation is currently the main risk facing the US economy. He also mentioned that in some cases, the Fed might need to raise rates, but if the Iran conflict is quickly resolved, the Fed could still cut rates later this year.

This would break one of the main bullish arguments for stocks. Since early last year, investors have been optimistic about rate cuts, as the Fed signaled a dovish stance amid cooling inflation, and lower rates have been a key factor in most Wall Street analysts’ bullish outlooks.

As concerns about rising inflation intensify, the market is now discussing the possibility of rate hikes.

Last week, US Bank stated that “whether the Fed will raise rates this year” has become a question their clients have been asking recently. The bank’s answer is: while the possibility cannot be completely ruled out, three conditions must be met for the Fed to hike rates: a stable labor market, further acceleration of inflation, and Powell’s continued tenure as Fed Chair.

Deutsche Bank: The Fed will avoid repeating past mistakes

Although recent reasons for not cutting rates have strengthened, Deutsche Bank analysts recently provided another reason why investors’ expectations for rate cuts are justified.

In a report to clients on Monday, the bank said the Fed might look at recent history when making decisions and choose a hawkish approach to avoid repeating the inflation surge of 2021 and 2022.

Deutsche Bank pointed out that during the 1979 oil crisis, the Fed adopted more aggressive rate hikes amid rampant inflation than in the early 1970s. Additionally, the bank noted that during the COVID-19 pandemic, the Fed implemented extremely dovish policies, whereas its response to the 2008 financial crisis was not sufficiently accommodative.

“A key lesson from past crises is that central banks will correct the mistakes made during previous crises,” wrote Henry Allen, Deutsche Bank’s macro strategist, in the report. “Therefore, as we face a new wave of inflation shocks, the Fed aims to avoid being criticized like in 2022, when their response to inflation was too loose. We see this understanding influencing current policy, meaning that when inflation reaches certain levels, the central bank will issue more hawkish statements.”

At the March Federal Open Market Committee meeting last week, Fed Chair Jerome Powell said the committee would closely monitor how the Iran conflict affects inflation data. He stated, “If we do not see progress on inflation, you won’t see rate cuts.”

On Monday, President Trump said that the US and Iran had held “productive” talks to end the conflict, so rate expectations could shift in the coming days or weeks. However, for now, the Strait of Hormuz remains closed, and the likelihood of rate cuts this year has significantly decreased.