BNY’s John Velis and David Tam said the May FOMC minutes, together with remarks from Fed Governor Waller, imply greater two-way risk for US interest rates. In response, they have removed their previous call for two rate cuts in 2026 and now project no policy change, unless oil flows through the Strait of Hormuz resume relatively soon, which they frame as early- to mid-summer. The May discussion was characterised by a more hawkish debate than they had expected, despite three dissents on the policy orientation of the FOMC statement.
Waller, who dissented in July 2025 over labour-market concerns and again in January 2026, said rates were as likely to rise as to fall, citing worries that short-term inflation expectations could feed into longer-term expectations. They added that cuts could return to the agenda if oil starts flowing through the Persian Gulf. They also expect Thursday’s PCE inflation report to show accelerating consumer prices, a backdrop they see as reinforcing the Fed’s hawkish lean.
Markets Reprice Interest Rate Outlook as Fed Turns More Hawkish
Given the more hawkish tone from the Federal Reserve, we believe the outlook for interest rates has fundamentally shifted. The market has rapidly repriced expectations, with data from CME Group now showing less than a 10% chance of a rate cut by September 2026, a dramatic drop from the 60% probability priced in just two months ago. We have therefore removed our forecast for any rate cuts this year.
The Fed’s primary concern is clearly inflation, which has proven persistent. Recent data, like the April 2026 Consumer Price Index showing an annual rate of 3.8%, underpins this worry about price pressures. This week’s Personal Consumption Expenditures (PCE) report will be critical, and we expect it to confirm this trend of accelerating prices, giving the Fed no reason to consider easing policy.
The critical variable for us remains the geopolitical situation in the Persian Gulf. The closure of the Strait of Hormuz is keeping energy prices elevated, with Brent crude futures holding stubbornly above $115 per barrel and directly feeding into inflation. We see no change in Fed policy until oil begins to flow freely again, which we now view as unlikely before mid-summer at the earliest.
Implications for Derivatives, Volatility, and Trading Strategy
For derivative traders, this environment suggests focusing on strategies that profit from sustained or rising interest rates. We are cautious about positioning for imminent rate cuts and instead see value in options on Treasury futures that bet on rates remaining higher for longer. This situation is reminiscent of past energy crises where central banks were forced to maintain tight policy to combat supply-driven inflation.
This heightened uncertainty also means higher market volatility, which we see reflected in the VIX index consistently trading above 20. Traders should consider buying options to protect portfolios or using strategies like straddles on major indices ahead of key inflation data releases. The clear pivot from influential Fed members like Governor Waller, who now sees rate hikes as just as likely as cuts, supports positioning for bigger market swings.
Our focus in the coming weeks will be twofold: any diplomatic news regarding the Strait of Hormuz and key inflation prints. A surprise reopening of the strait would cause us to immediately re-evaluate our stance and could quickly put rate cuts back on the table. Until then, the path of least resistance for interest rates appears to be sideways to higher.
