The market's expectation for the Federal Reserve to cut interest rates this year is cooling significantly as U.S. economic data continues to show resilience and global energy prices remain elevated due to Middle Eastern tensions. According to the latest analysis from BNY Mellon strategists John Velis and David Tan, recent U.S. macroeconomic data from the past two weeks indicates the U.S. economy has not yet been severely impacted by the Middle East situation and the energy shock.
In particular, recent U.S. employment figures have remained broadly robust. Data shows U.S. non-farm payrolls increased by 115,000 in April, which, while slowing from previous levels, still indicates some resilience in the labor market. However, household survey data revealed an increase of 134,000 unemployed persons and a decrease of 226,000 employed persons. This suggests that certain signs of divergence are beginning to appear within the U.S. labor market.
The primary market contradiction currently lies in the simultaneous presence of "economic resilience" and "potential slowdown risks."
On one hand, the U.S. job market has not deteriorated significantly, with consumer spending and overall economic activity remaining stable. On the other hand, high energy prices and the persistently elevated interest rate environment are gradually increasing downside economic risks. The most critical variable for the market remains U.S. inflation performance. The market anticipates that the year-on-year increase in the U.S. Consumer Price Index (CPI) for April may rise to 3.7%, up from the previous level of 3.3%, while the Producer Price Index (PPI) is also likely to remain high.
BNY Mellon believes that in a high inflation environment, the Federal Reserve will find it difficult to have the conditions for rate cuts in the near term. Rising international oil prices and risks to shipping through the Strait of Hormuz are reinforcing market concerns about "secondary inflation." Due to the ongoing tensions in the Middle East, shipping issues in the Strait of Hormuz have not substantially improved. The market worries that if global energy supply continues to be disrupted, international oil prices may remain elevated, thereby increasing global inflationary pressures.
BNY Mellon points out that its forecast for two rate cuts in the fourth quarter of 2026 is based on two key prerequisites.
First, the Strait of Hormuz must reopen, leading to a decline in international oil prices. The institution believes that only a significant drop in energy prices would allow the Fed to refocus its policy priorities on the job market rather than inflation.
Second, the U.S. labor market needs to weaken further. Only if the U.S. unemployment rate rises significantly in the future and job growth continues to slow would the Fed be likely to adopt a more dovish stance.
However, the institution also acknowledges that neither of these conditions is currently in place in the short term. The Middle East situation remains tense, and while there are some signs of slowing in the U.S. labor market, it remains relatively stable overall.
Nevertheless, BNY Mellon still believes these conditions could gradually materialize by the end of the third quarter, potentially prompting a shift in the Fed's policy stance.
It is worth noting that internal discussions at the Fed's April meeting have already begun to focus more on future policy risks. While no official explicitly opposed the direction of interest rate policy at the time, some officials expressed differing views on the wording of the policy statement. This indicates that the Fed has started to pay attention to two-way policy risks, not just the single risk of inflation. The market views this change as a sign that the Fed is gradually preserving room for a potential future policy pivot.
Looking at global financial market performance, the U.S. Dollar Index remains strong, U.S. Treasury yields are generally operating at high levels, while precious metals markets like gold and silver continue to be influenced by both "high-rate expectations" and "safe-haven demand." Meanwhile, international oil prices continue to trade at elevated levels. Brent crude is currently trading around $104, with the market remaining highly vigilant about Middle East energy supply risks.
From a technical structure perspective, the U.S. Dollar Index is currently maintaining a pattern of rebounding from lows. Market expectations that the Fed will "keep rates higher for longer" are becoming a key support factor for the dollar. Regarding U.S. Treasury yields, the 10-year yield has been rebounding recently, indicating the market is readjusting its pricing for the future path of rate cuts.
Overall, the core market narrative has shifted from the previous "rate cut trade" to a "high inflation + sustained high rates" trading pattern. The situation in the Middle East and changes in energy prices will continue to be important variables influencing expectations for Fed policy.
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