Rate‑Cut Expectations Only Halfway There — Why the Shadow of Rate Hikes Is Making a Comeback

Markets repriced in a heartbeat

Global markets were pricing in a year of central‑bank easing. Then, in quick succession, the Reserve Bank of Australia surprised with a 25bp hike, the Bank of England warned it would tighten if inflation didn’t fall, and the ECB and Bank of Japan issued hawkish signals. Equity, bond and gold markets dumped. Traders have repriced roughly 50–100 basis points of extra tightening for major central banks this year. Why the volte‑face? Short answer: a renewed geopolitical shock combined with a fragile macro backdrop that makes any oil shock feel far more dangerous than the data actually are.

Geopolitics, oil and the PTSD of 2022

It has been reported that tensions in Iran have surged since March, and reportedly the Trump administration has been testing international reactions through public signalling. It has also been reported that Iran rejected a U.S. ultimatum. Markets worry that a ground conflict or attacks on Gulf infrastructure — or a closure of the Strait of Hormuz or the Bab al‑Mandeb near the Mandeb/Manila shipping lanes — would send oil sharply higher. Investors still remember 2022: energy‑driven inflation cascaded into broad price rises and forced aggressive global tightening. The simple chain — oil up, inflation up, central banks forced to hike — has returned to traders’ screens.

Economic fundamentals give central banks some room to breathe

But the macro picture differs from 2022. Manufacturing PMIs have fallen from 55–60 boom levels to around the 50 threshold, U.S. hiring is cooling, wage growth is moderating, and long‑term inflation expectations remain anchored. Energy accounts for only about 7% of U.S. CPI; a $10 rise in oil roughly lifts headline CPI by 0.2–0.3 percentage points, yet core inflation depends on wages and service‑price dynamics. That divergence is why the Federal Reserve and the ECB can plausibly “look through” a short‑lived energy spike and stay on hold unless second‑round effects — firms raising prices and workers demanding higher pay — materialise.

Who’s most exposed? Japan and international banks

The clearest upside risk is the Bank of Japan. Unlike Europe or the U.S., Japan has been flirting with a self‑reinforcing wage‑price loop: rising pay expectations, pass‑through pricing and early disanchoring of inflation expectations. Markets are already pricing meaningful BOJ tightening. For banks, the policy whipsaw and geopolitical uncertainty are not abstract: they raise ALM risk, FX volatility, trade‑finance exposures and country‑risk calculations. Carry trades and cross‑currency funding can flip from profit to peril if policy paths diverge or a sudden shock forces rapid repricing. Bottom line: absent persistent second‑round inflation, a broad, coordinated re‑start of hiking looks unlikely — but Japan and banks with large Gulf or FX exposures should be on high alert.