Behind the gasoline "breaking 4": The Federal Reserve is even less daring to raise interest rates, only able to cut rates?

Ask AI · Why Soaring Gasoline Prices Make the Fed More Worried About Recession?

Cailian Press, April 1 (Editor: Xiaoxiang) This week, the average retail gasoline price in the United States officially broke through $4 per gallon, reflecting ongoing supply shocks in the energy market. Interestingly, while this seems to signal that the Fed might raise interest rates to curb inflation, at least for now, the answer may be quite the opposite…

On Tuesday, investors instead expect the Federal Reserve to keep the benchmark interest rate unchanged, and possibly even shift to rate cuts later this year, as policymakers weigh the risks brought by rising energy prices—risks that could more likely slow economic growth rather than trigger persistent inflation.

In a speech on Monday that could influence market trends, Fed Chair Jerome Powell also hinted that for an economy already facing a softening labor market and growing Wall Street concerns about a recession, raising rates at this time might not be the best remedy—when asked whether policymakers should consider rate hikes now, Powell responded, “By the time the effects of monetary tightening are evident, oil shocks may have already passed, and you’d be exerting pressure on the economy at an inopportune time. Therefore, our inclination is to ignore any form of supply shocks.”

These comments came at a critical market juncture. Previously, due to a series of conflicting and evolving economic signals, markets had struggled to grasp the Fed’s true intentions. Just last week, traders were seriously contemplating the risk that the Fed’s next move might be a rate hike.

However, Powell’s remarks—despite their typical Fed diplomatic tone that leaves open the possibility of either rate hikes or cuts—helped the market retreat from a hawkish stance. Bond traders abandoned bets on rising inflation and shifted focus to the potential economic slowdown caused by high oil prices.

As shown in the chart below, early last week, futures markets generally expected a rate hike by the end of the year. Now, the interest rate swap market reflects about a 6 basis point cut by the end of 2026, roughly a 25% probability. Ian Lyngen, head of U.S. interest rate strategy at BMO Capital Markets, said investors “now see energy shocks as equally or more important than inflation concerns for global economic growth.”

This dramatic shift is evident in options markets linked to the secured overnight financing rate (SOFR), which closely correlates with central bank policy expectations. On Monday, open interest—indicating traders’ risk exposure—showed that many hawkish positions hedging against imminent Fed rate hikes had been closed out at a loss.

Fighting inflation, stabilizing the economy?

Rob Subbaraman, head of global macro research at Nomura Securities, wrote in a recent report that in addressing high prices, central bank officials will ultimately be “sharp-tongued but slow to act.”

He added, “Currently, with overall inflation soaring, the strategy of keeping rates steady while maintaining a hawkish stance helps stabilize inflation expectations, which makes sense. However… the transmission of rising oil prices to wage growth and core inflation may be limited, and instead, the Middle East conflict could quickly escalate into a global economic growth shock.”

In fact, recent industry concerns about how soaring oil prices will impact economic growth have surpassed worries about inflation itself, aligning with Powell’s view—that raising rates now cannot solve energy costs and may cause more trouble in the future. Policymakers are more worried about the risk that energy-driven inflation could weaken consumer demand and employment.

Joseph Brusuelas, chief economist at RSM, said policymakers should be wary of “demand destruction” triggered by energy shocks.

“Time is not on the side of the U.S. economy,” he wrote in the article, “The bigger risk is what happens next: demand destruction. This is the economic term for the phenomenon where high prices force individuals and businesses to cut back spending. It sounds abstract, but it’s very concrete—it means fewer car sales, less home buying, fewer dining out, less business investment, and ultimately, job losses.”

Brusuelas added that the Fed is caught in a policy dilemma: raising rates now could further slow economic growth, while remaining on hold risks worsening the oil price situation.

“This is a classic stagflation dilemma with no perfect solution,” he said. “If conditions worsen further, the Fed will act. But we believe the Fed is more likely to be patient, and when it finally acts, it will do so with a lag, further dampening demand before making large rate cuts.”

Jason Thomas, head of global research and investment strategy at Carlyle Group, also expressed similar concerns, stating that the Fed might be forced not only to cut rates but to do so by more than the usual 25 basis points each time.

This dynamic highlights a shift in how the Fed responds to shocks—no longer focusing solely on temporary price spikes, but paying more attention to broader economic impacts. Thomas wrote, “In the face of temporary supply shocks severely impacting the labor market, the Fed will not stand idly by. Under this economic scenario, rate cuts could start as early as September, and the cuts are likely to be larger than 25 basis points.”

(Cailian Press, Xiaoxiang)