Market participants note that escalating Middle East tensions are driving up oil prices, bringing energy-driven inflation risks back to the forefront and rapidly increasing expectations for Federal Reserve interest rate hikes. As artificial intelligence (AI) trading momentum cools, key US inflation data like the CPI and the earnings season this week will become the market's focal point, with their outcomes directly influencing the Fed's policy path and global equity trends.
Analyst Damir Tokic stated that the market is currently dominated by two major themes—inflation and the AI bubble—both of which are applying significant pressure on stocks. He added that these two themes will continue to dominate, especially with the upcoming US Consumer Price Index (CPI) data release and the approaching earnings season.
The analyst also pointed out that AI trading has faced setbacks in Asian markets, dragging down the US semiconductor sector. He views this trend as "consistent with the characteristics of a gradually deflating AI bubble."
Tokic remarked, "With the escalation in the Middle East, the market has already begun pricing in a Fed rate hike in September and expects a total of two hikes by May 2027."
"The risk of an inflation shock triggered by rising energy prices has re-entered the market's view."
Although futures traders and prediction markets still widely expect the Federal Reserve to hold rates steady again at its July meeting, bets on the central bank taking action at that time are rising.
On Monday, market bets on a Fed rate hike continued to intensify. According to the CME Group's FedWatch Tool, the market-implied probability of a 25-basis-point rate hike by the Fed on July 29 has risen to 46.5%, up from 34% last Sunday. On the prediction market platform Kalshi, traders currently see a 36% chance of a Fed rate hike, higher than the less than 20% level last Sunday and far above the less than 10% probability at the beginning of the month.
The升温 in Fed rate hike expectations coincides with the US President announcing the re-imposition of a blockade on Iranian ports near the Strait of Hormuz and a 20% transit fee on all goods shipped through the strait. As US-Iran tensions have recently flared again, international oil prices have risen, exacerbating concerns that inflation will remain elevated for longer and force the Fed to hike rates.
Consequently, investors will closely watch the upcoming key US inflation data for June, including the Consumer Price Index (CPI) and wholesale prices. These will be the final inflation reports released before the Fed's policy meeting later this month, thus providing crucial clues for assessing the future interest rate outlook.
Economists forecast that both the headline CPI and the core CPI excluding food and energy for June will show a slight deceleration in year-over-year growth compared to May—with the US June CPI expected to rise 3.8% year-over-year, down from the 4.2% increase in May—but both metrics will remain significantly above the Fed's 2% inflation target.
Against the backdrop of renewed US-Iran tensions and continued oil price increases, the inflation outlook could become more complicated.
Neil Dutta, Head of Economic Research at macroeconomic and financial markets research firm Renaissance Macro, has further reinforced market concerns that the Fed might act. Dutta stated, "The US economy is currently closer to achieving the Fed's goals for growth and employment than it is to its inflation target. Therefore, based on recent changes in the Federal Open Market Committee's (FOMC) rhetoric, I believe the bar for the Fed to hike rates again is relatively low."
Mark-André Fongern, Integrated Portfolio Management Advisor and Director at Moelis & Company, warned that geopolitical conflicts could have ripple effects on credit markets. Fongern said, "Simply put, the longer it takes for global oil shipments and the Strait of Hormuz to return to normal, the higher the probability of further Fed rate hikes, and consequently, the greater the likelihood of increased pressure on the private credit market."
He concluded with a warning: "We are now walking on thin ice!"
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