Strait of Hormuz Set to Reopen, How New Fed Chair Warsh Walks a Tightrope Amid Market Expectations?

TradingKey - The Federal Reserve is set to announce its policy decision this Wednesday, which will also be the first rate-setting meeting chaired by the new Chairman, Kevin Warsh. Currently, global investors are closely watching the new chairman's policy stance, particularly against the backdrop of the imminent reopening of the Strait of Hormuz and signs that core inflation is cooling.

Economists widely expect the Federal Open Market Committee to keep its benchmark interest rate unchanged in the 3.5% to 3.75% range, while assessing the actual economic impact of the energy price shocks resulting from the war in Iran.

Easing geopolitical tensions relieves inflationary pressures

The United States and Iran announced a truce memorandum of understanding on June 14, paving the way for the reopening of the Strait of Hormuz, a vital global energy transit chokepoint.

U.S. President Donald Trump posted on social media that the agreement between the U.S. and Iran is "now complete," and that he has "authorized" the Strait of Hormuz to "open for free" and the U.S. Navy to immediately lift the related blockade. Once both parties formally sign the agreement on June 19, the Strait of Hormuz may "reopen" on that day.

The news immediately triggered a chain reaction in energy markets, sending international oil prices to a three-month low on Monday. At the same time, data showed that gasoline prices have been declining for a consecutive month, with the U.S. national average dropping from about $4.50 to $4.00 per gallon, and is expected to fall further in line with other energy commodities.

This trend will bring at least several months of negative headline inflation readings over the coming months, prompting Federal Reserve officials to shift their characterization of energy prices from an "inflation risk" to a "neutral or even deflationary factor."

The easing of geopolitical tensions directly cooled inflation expectations, which in turn caused market expectations for Federal Reserve rate hikes to soften.

According to CME Group data, based on federal funds futures trading, the market-implied probability of a rate hike by year-end has dropped to 58% on Monday, down from just over 66% last Friday. On Monday, the probability of keeping interest rates unchanged was 41.4%, while the probability of a rate cut was 0.6%.

Core inflation shows signs of cooling, with divergence among inflation indicators intensifying.

Although the May core PCE price index is expected to remain sticky due to the impact of the earlier surge in energy costs, the more sensitive core CPI data was unexpectedly cool, rising just 0.21% month-on-month.

Within the Federal Reserve's complex inflation monitoring matrix, the trimmed-mean PCE and core CPI are gradually converging toward the 2% target level, and their clear downward trend contrasts sharply with the stubbornness of the core PCE.

This divergence among indicators suggests that, once volatile food and energy are excluded, underlying inflationary pressures are not spinning out of control as previously feared.

Fed Decision Imminent

UBS ( UBS) Leslie Falconio, head of taxable fixed income strategy at UBS Global Wealth Management, said that falling oil prices are easing the pressure on Warsh to raise interest rates.

She pointed out that before the ceasefire news emerged, "the two-year yield was still rising because the market was pricing in a near-100% probability of a rate hike in December 2026," and as oil prices fell, the market is pricing out those rate hike expectations, thereby driving short-end yields down.

Vincent Ahn, president and portfolio manager at Income Research + Management, said: "My view is that the threshold for an actual rate hike is much higher than what market pricing implies, especially as the key variable that sparked the discussion (geopolitical tensions) is receding."

He added: "I don't think rate hikes were ever the right tool for this issue. You can't raise rates to get the global economy to produce more oil."

Currently, global capital markets are focused on the upcoming speech by Fed Chairman Warsh. If his remarks are more dovish than market expectations, it could accelerate the market's repricing of the Fed's future rate-cut path.