Will the Strait of Hormuz resume operations, and will the Federal Reserve pivot to a “dovish” stance, prompting markets to repricing rate cuts?

By: Zhao Ying

Source: WallStreetCN

Two key catalysts driving inflation lower are now unfolding simultaneously, providing Federal Reserve Chair Powell with ample justification to adopt a more dovish stance at this week’s Federal Open Market Committee (FOMC) meeting.

According to Wind Trading Desk, Citigroup Research’s report released on June 15 noted that the anticipated reopening of the Strait of Hormuz would push oil prices lower, eliminating energy prices as an upside risk to inflation. Meanwhile, last week’s core CPI data came in notably soft, with a month-on-month increase of just 0.21%.

The confluence of these two developments further erodes the rationale for the Fed to maintain its hawkish posture, bringing rate cuts back onto the table.

For markets, this assessment carries direct pricing implications. The two-year Treasury yield has declined by approximately 13 basis points over the past week, yet remains over 60 basis points higher than its February level. Markets still have room to pare back pricing for further hikes—and room to increase pricing for rate cuts.

Easing Energy Price Pressures, Diminishing Upside Inflation Risks

Expectations surrounding the Strait of Hormuz’s reopening constitute one of the core drivers behind the current dovish narrative. Once navigation resumes, increased crude oil supply will drive down oil and broader energy prices.

Gasoline prices have fallen for a full month, with the national average declining from roughly $4.50 per gallon to $4.00. Citigroup expects gasoline prices to continue falling in line with other energy commodities. This trend is expected to generate at least several months of negative headline inflation readings and prompt Fed officials to reclassify energy prices—from an “inflation risk” to a “neutral or even deflationary factor.”

Core CPI Cools, Divergence Among Inflation Metrics Widens

On the core inflation front, while May’s core PCE is still expected to remain strong, core CPI has already shown clear signs of cooling, posting only a 0.21% month-on-month gain.

Core PCE has increasingly become an “outlier” among current inflation indicators—both trimmed-mean PCE and core CPI are closer to the Fed’s target and exhibit clearer downward trends. This divergence is gaining broader recognition among both market participants and Fed officials, lending empirical support to a dovish stance.

Hawkish FOMC Adjustments Already Fully Priced In; Room for Dovish Shift Remains

The report forecasts that this week’s FOMC statement will drop the phrase “bias toward easing,” and the median projection in the interest-rate dot plot will indicate no change in rates this year. However, these hawkish adjustments have already been fully anticipated by markets and thus offer no new information.

The true variable lies in Powell’s wording. Given the latest developments—including the Strait of Hormuz reopening and the cooling trend in core inflation—the risk of Powell delivering a dovish signal at this meeting is tilting upward. Should his tone prove milder than expected, markets may accelerate their repricing of the rate-cut path.

U.S. Treasury Yields Still Have Room to Fall; Market Pricing Still Adjustable

From a market-pricing perspective, the report argues that current interest-rate futures still imply an elevated probability of further hikes. Although the two-year Treasury yield has declined about 13 basis points over the past week, it remains over 60 basis points above its February level—indicating markets have yet to fully digest the implications of easing inflation risks.

As the inflation upside risks that previously supported hawkish expectations gradually dissipate, markets are likely to further reduce pricing for hikes while simultaneously increasing pricing for cuts—leaving room for U.S. Treasury yields to fall further.