- Traders are pricing in a 90% chance of a 25-basis-point Fed rate hike.
- Iraq attacked a major oil pipeline in Saudi Arabia that bypasses the Strait of Hormuz.
- Experts expect more than one rate hike this year.
Equities pulled back on Tuesday as market participants prepared for the FOMC policy meeting. Fundamentals support a rate hike on Wednesday as the Fed tries to tame inflation and cool the economy. The tensions in the Middle East have caused a significant surge in oil prices, fueling price pressures.
After months of speculation, market participants expect the Fed to hike interest rates on Wednesday. According to futures markets, there is a 90% chance of a 25-basis-point hike. Higher borrowing costs are bearish for equities because they lower future company earnings.
Chip Stocks Performance (Source: Bloomberg)
When it becomes harder to borrow money, it becomes difficult to grow. High-value companies and the tech sector, which depend heavily on borrowing, suffer the most.
Since February, the war in Iran has shaped the outlook for monetary policy in the US and around the globe. The war has caused significant supply disruptions and damage to oil facilities, especially in recent days. The closure of the Strait of Hormuz has led to little traffic and reduced supplies to the global economy.
Meanwhile, the conflict has escalated to include major oil producer Saudi Arabia. Iran’s allies, the Houthis, have repeatedly hit targets in Saudi Arabia. At the same time, reports last week revealed that Iraq attacked a major oil pipeline in Saudi Arabia that bypasses the Strait of Hormuz. The attack caused significant damage, forcing the temporary closure of the pipeline.
This war has clouded the outlook for oil supply, causing a sharp spike in oil prices. Furthermore, there is little hope for peace with no talks currently on the horizon. According to Trump, if the US keeps attacking Iran, the country will eventually be unable to fight back. As a result, he expects the war to end soon.
However, with no clear path to peace or a deal to end the war, oil prices will continue to climb, fueling inflation. Moreover, the war might eventually slow the US economy, putting the Fed in a tight spot as policymakers balance growth and inflation.
Recent labor market data revealed robust growth, giving the central bank room to hike interest rates. Consequently, experts expect more than one such move this year that could weigh on equities.
