As traders bet on the Federal Reserve raising interest rates, analysts are "taking the opposite side": at least one rate cut this year, as early as September!

Ask AI · Why do interest-rate outlook disagreements between traders and economists keep widening?

The Federal Reserve faces a dilemma amid shocks from the war in the Middle East—clear divergences have emerged between economists and market traders in their assessment of the interest-rate outlook.

In a Reuters survey conducted March 20 to 25 of 82 economists, nearly three-quarters of respondents expect the Federal Reserve will not cut rates at least until September this year, but most still maintain a baseline expectation of at least one rate cut within the year.

Meanwhile, market traders are sharply increasing bets on Federal Reserve rate hikes. In the swaps market, the implied probability of a rate hike this year is currently above 50%, and the expectation gap between economists and the market continues to widen.

The war between the United States and Israel against Iran has entered its fourth week. International oil prices have risen by more than 40% in total, and inflation pressures have surged. The Federal Reserve held the benchmark interest-rate range at 3.50% to 3.75% unchanged last week. Several officials then sent signals placing inflation risks as the top priority, leaving the likelihood of rate cuts in the near term extremely limited.

Economists: The rate-cut window is pushed back to September, but there is still room within the year

Reuters’ survey shows that among the 82 economists surveyed, 61 expect the Federal Reserve to hold steady in the next quarter. Just two weeks ago, about two-thirds of respondents still expected a rate cut to the 3.25% to 3.50% range by the end of June. Fifty-five economists believe the first rate cut will not happen until at least September.

Barclays’ senior U.S. economist Jonathan Millar said, “The Federal Reserve needs more time to be confident that inflation is returning to a track consistent with the 2% target, and we think this timing won’t be earlier than September.” He also noted that “the Federal Reserve very well could stand pat on the oil-price trajectory for a longer period and push the rate cut into next year.”

On the direction of year-end interest rates, the economists surveyed are split: 37 expect two rate cuts, 28 expect one rate cut, 13 expect it to stay unchanged for the full year, and 4 expect three rate cuts. The median projection in last week’s Federal Open Market Committee (FOMC) dot plot indicates one rate cut within the year. Among the 75 economists who took part in the latest survey and also in the prior survey before the March 17 to 18 policy meeting, about 45% have moved their rate-cut expectations further back.

Rate-hike bets intensify, and the Treasury curve’s bear flattening takes hold

Unlike the relative restraint shown by economists, market traders have reacted more aggressively. According to Bloomberg, as oil prices rise and news related to Iran ceasefire talks remains contradictory, traders keep adding to bets on Federal Reserve rate hikes, and the U.S. Treasury yield curve has shown a bear-flattening trend.

The swaps market currently implies a 13-basis-point rate hike before October. Traders generally believe this will be the peak of the current rate-hike cycle, while Wednesday’s figure was only 8 basis points. The tightening priced in before December is 11 basis points. Financial markets have largely ruled out the possibility of a rate cut within the year and have priced the probability of rate hikes at close to 30%.

U.S. 2-year Treasury yields have risen by more than 55 basis points compared with before the war. Financial conditions have effectively tightened on their own, even without the Federal Reserve using the federal funds rate. Jonathan Millar commented on this by saying, “I don’t think this is a situation where the financial markets are truly driving the Federal Reserve,” and emphasized that the tightening of financial conditions has been operating independently as well.

Inflation expectations have been sharply raised, and the newly appointed Federal Reserve chair faces pressure

Economists have recently raised their inflation forecasts significantly, mainly focusing on the broad inflation measures.

Reuters’ survey shows that the Federal Reserve’s preferred inflation gauge, the personal consumption expenditures (PCE) price index, is expected to rise year over year by 3.3%, 3.1%, and 2.9% in the second, third, and fourth quarters of this year, respectively. Compared with two weeks ago, these forecasts were generally raised by about 50 basis points and are all higher than the Federal Reserve’s latest official forecast. Notably, before the war broke out, U.S. inflation was already about one percentage point above the Federal Reserve’s 2% target.

At the political level, Trump has nominated Kevin Warsh to serve as the next Federal Reserve chair and has repeatedly criticized the current chair, Powell, for moving too slowly on rate cuts.

Jan Groen, chief U.S. economist at Société Générale, said, “Any chair who, after taking office, is asked to cut rates significantly will find it at least difficult—this year—to build consensus within the committee.” He also emphasized, “All the factors related to the Iran war and its impact on the oil market are adding to concerns about inflation.”