Bank of America: Market expects the Federal Reserve to adopt a "more hawkish response mechanism"

Investing.com - Analysts at Bank of America Securities state that the market currently expects the Federal Reserve to respond more aggressively to signs of rising inflation than previously anticipated.

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The recent energy shock triggered by the Iran war has nearly erased bets on interest rate cuts by the Federal Reserve this year, while bets on policymakers potentially raising rates in the coming months have emerged.

In a report on Friday, strategists including Aditya Bhave pointed out that from the outbreak of the Iran war in late February to last week’s Federal Reserve meeting, the yield on the 2-year U.S. Treasury bonds sensitive to interest rates fluctuated “almost in sync” with U.S. WTI crude oil futures, the benchmark for American oil.

However, they emphasized that from that meeting until the close of trading in the U.S. on Thursday afternoon, the 2-year Treasury yield rose nearly 30 basis points, while U.S. WTI crude oil saw a slight decline.

These analysts stated, “We believe this is because the market is pricing in a more hawkish Federal Reserve response,” as comments made by Federal Reserve Chairman Jerome Powell after the meeting indicated that officials are focusing on the inflation implications of the conflict.

Bank of America strategists noted that Federal Reserve Governor Christopher Waller’s statements in a recent interview “sounded very concerned” about the surge in oil prices due to the Middle East war, reinforcing their analysis.

“Given the supply disruptions of gas, fertilizers, helium, and more, the market may also be anticipating broader commodity shocks, which could translate to core inflation,” they stated.

On Friday, U.S. WTI crude rose 3.7% to $98.01 per barrel, while the yield on the 2-year U.S. Treasury bonds fell slightly by 2 basis points to 3.963%. Traders are assessing President Donald Trump’s decision to further postpone the deadline for Iran to reopen the Strait of Hormuz to April 6, or face U.S. airstrikes.

Trump claimed in a post on Truth Social that the delay was at the request of the Iranian government, adding that Tehran is engaged in “ongoing” negotiations with the U.S., and that the talks are “going very well.” He insisted that contrary media reports are “false.”

Trump had previously issued an ultimatum to Iran over the weekend, vowing to strike the country’s power plants if it did not lift its blockade of the Strait of Hormuz. The Strait of Hormuz is a crucial waterway through which about one-fifth of the world’s oil flows. He later stated that he would delay action until Friday after what he described as “very strong” discussions with Iran.

Tehran has publicly denied any such negotiations with Washington.

A report from the OECD on Thursday warned that the global economic outlook is dim due to the war, emphasizing the risks of inflationary pressures triggered by energy price shocks, which could weigh on overall growth.

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