Skyrocketing oil prices hit the bottom line of inflation: the Fed's decision not to cut interest rates this year is shifting from an extreme assumption to the mainstream of the market.

Due to the escalation of the Middle East conflict pushing up oil prices and potentially exacerbating inflation expectations, bond options traders are increasingly betting that the Federal Reserve will abandon its rate-cutting plan this year. According to the latest data compiled by the Atlanta Fed, as of this Wednesday, traders believe there is a 25% probability that the Fed will keep the benchmark interest rate unchanged in its current range before December. This probability has significantly increased from 17% on the last trading day before the outbreak of the Iran conflict last Friday, reflecting the rapid adjustment of market expectations for a Fed monetary policy shift. Maintaining the interest rate unchanged has become the most likely single outcome in various policy scenarios. According to data from the Atlanta Fed, in other scenarios, the probability of a 25-basis-point rate cut is 24%, and the probability of two rate cuts is 12%. Traders even believe that the probability of a rate hike is as high as 16%, a significant increase from 8% on the last trading day before the outbreak of the Iran conflict last Friday. These data are all based on calculations of overnight financing rates (SOFR) futures options linked to the Fed's policy rate. "When oil prices surge, we must prioritize its transmission effect on inflation," emphasized Dan Carter, Senior Portfolio Manager at Ford Washington Investment Advisors. "This will directly push up inflation expectations, thereby significantly reducing the likelihood of a Fed rate cut." Although the overall probability distribution still shows a bias towards rate cuts after considering all possible scenarios, the significant shift in pricing reveals market confidence has been severely shaken - with oil prices soaring nearly 20% this week, traders' confidence in the Fed's ability to lower borrowing costs has been greatly weakened. Option trading flows in recent days clearly indicate that the demand to hedge risks of a reduced degree of Fed accommodation remains. As another key tool for betting on Fed policy, the interest rate swap market also reflects expectations that the central bank's stance will become less dovish. Traders currently expect the Fed to cut rates by about 35 basis points by the end of the year, compared to expectations of 60 basis points last weekend. This sharp cooling of rate cut expectations has directly triggered a recent sell-off in US treasuries, pushing yields to multi-week highs and marking a complete reversal of the strong rally seen in February. Back then, concerns about the disruptive impact of artificial intelligence, combined with signs of cracks in the private credit market, stimulated a surge in safe-haven demand. Now, with inflation risks resurfacing due to the surge in oil prices, market logic has fundamentally shifted.