UBS Tempers Fed Rate Cut Expectations Amid Inflation Concerns

-- The Federal Reserve will now likely deliver just one interest rate cut this year instead of two amid the oil price shock from the Middle East conflict, though the risks for the next rate reduction skew toward earlier rather than later, UBS Securities said in a note e-mailed Monday.

Energy prices have soared following the US-Israel war with Iran that started at the end of February, with the crucial Strait of Hormuz effectively closed. Oil prices hovered around $100 a barrel intraday Monday as the deadline passed for the start of a US blockade of maritime traffic around Iran's ports.

"Headed into the oil price shock, we projected two rate cuts this year with risk of one," UBS economists, including Jonathan Pingle, said in a note to clients. "We now expect only one, a (25-basis-point) rate cut at the December (Federal Open Market Committee) meeting."

The brokerage said the risks skew toward earlier rather than later for the next rate cut, based on its current assessment of the distribution of risks.

"Despite our assessment of FOMC dynamics and the labor market pointing to risk of nearer rate cuts, if the economy is not weakening sufficiently, or in time, and core and headline inflation are at or above 3%, there probably won't be much inclination to lower rates among the FOMC participants," the UBS economists wrote. "Evidence of any labor market weakness likely needs to accumulate before eliciting a response, and that takes time."

Over the weekend, the US and Iran failed to reach a deal during negotiations in Pakistan, fueling concerns over an already fragile ceasefire between Washington and Tehran announced last week.

Last week, minutes from the FOMC's March meeting showed that policymakers emphasized the need to be "nimble" in adjusting interest rates in light of heightened risks to inflation and employment driven by the Middle East conflict.

Markets widely expect the Fed to keep interest rates unchanged at its meeting later this month, according to the CME FedWatch tool.

For 2027, UBS is looking at two quarter-percentage-point rate cuts, according to the note.