Key Points

Following a ceasefire agreement between the United States and Iran, traders are beginning to factor in the possibility of interest rate cuts by the end of the year. On Wednesday morning, the probability of a rate cut surged significantly to approximately 43%, compared to just 14% before the news broke.

Traders are now considering the likelihood of year-end interest rate cuts as geopolitical tensions ease with the US-Iran ceasefire. According to the CME Group's FedWatch Tool, which gauges market expectations for Federal Reserve policy moves using 30-day federal funds futures contracts, the probability of a rate cut jumped sharply to around 43% on Wednesday morning. Prior to the announcement, this probability stood at only 14%. Market pricing suggests the overnight benchmark rate could fall to 3.5% by December, compared to the current effective rate of 3.64%. Previously, traders had anticipated the Federal Reserve would hesitate to cut rates this year due to the Iran conflict driving up energy prices, which threatened the central bank's efforts to return inflation to its 2% target. Before that, markets had expected multiple rate cuts to support a softening labor market. With at least a fragile peace emerging in the Middle East, market sentiment is shifting back towards the possibility of monetary easing. Krishna Guha, Vice Chairman of Evercore ISI, stated in a report, "The market has now priced in a clear bias toward at least one Fed rate cut this year." He added, "Assuming the agreed deal has flaws, there is room for this repricing to continue, and the risk of an incoming inflation shock threatening inflation expectations has decreased substantially." Guha also suggested that global peers, including the Bank of England, the European Central Bank, and the Bank of Japan, could potentially ease policy as well. In the US, markets are awaiting two key inflation reports this week, offering different perspectives on price pressures. The US Commerce Department will release the Personal Consumption Expenditures (PCE) price index on Thursday, the Fed's preferred inflation gauge, which will reflect February's inflation levels before the outbreak of the Middle East conflict. Subsequently, the Bureau of Labor Statistics will publish the March Consumer Price Index (CPI) on Friday, which will capture the impact of the geopolitical conflict on prices. According to a consensus survey by Dow Jones, economists expect the PCE report to show headline inflation at 3.0% and core inflation, excluding food and energy, at 2.8%. Expectations for the March CPI are 3.3% for the headline rate and 2.7% for the core rate, with the overall price level reflecting war-driven energy price increases. Guha emphasized that the possibility of a lasting US-Iran peace remains uncertain and expects policymakers to maintain a generally cautious tone in the coming months. He added, "At that point, provided subsequent information is reassuring, the policy stance could begin shifting back towards a more accommodative bias from late summer, creating room for one or even two rate cuts later this year."