Oil Slides to Lowest Level Since the War Began, While Fed Outlook Remains Unclear

U.S. benchmark crude oil prices dropped below $70 per barrel on Wednesday, hitting their lowest point since the conflict with Iran erupted on Feb. 28. The decline is expected to reduce pressure on headline inflation in the months ahead. However, the key issue now is whether the bond market will also adjust by pricing in lower inflation expectations, as uncertainty surrounding the Federal Reserve’s interest-rate path remains unresolved.

Oil prices were pressured by a preliminary agreement aimed at ending the conflict with Iran, while shipping activity through the Strait of Hormuz has started to recover gradually. Even so, energy transport volumes are still significantly below levels seen before the war. “What shippers are looking for is consistency over days and weeks,” said Matthew Wright, a freight analyst at Kpler, a firm specializing in global shipping analysis.

The oil market is currently reflecting expectations of continued progress toward stability and a gradual recovery in global energy exports over the coming weeks and months. “Traders are pricing in a return to normality,” said Francis Osborne, head of oil analysis at Argus Media, a firm that monitors global oil prices. “They are not taking into account the risks further down the road, which still remain very real.”

Despite ongoing uncertainty surrounding the Middle East, U.S. Treasury yields have started to retreat, though the decline has been uneven across maturities. The 30-year Treasury yield — typically the most sensitive to inflation expectations — dropped sharply yesterday to 4.84%, its lowest level in several months. Meanwhile, the benchmark 10-year yield also moved lower, reversing much of the increase seen over the past month.

One key exception is the policy-sensitive 2-year Treasury yield. Although it edged lower yesterday, it remained near 4.16%, close to the recent high reached only days earlier. This suggests that investors are not yet fully convinced that inflation pressures have disappeared or that further Federal Reserve rate hikes are off the table.

Torsten Slok argues that lower oil prices could ultimately become inflationary, writing:

“The narrative in markets is changing from ‘lower oil prices mean lower inflation’ to ‘lower oil prices mean more demand in an already overheating economy, which means higher inflation.’ Driven by the strong April CPI, hot May non-farm payrolls, and a hawkish Fed, the market narrative now suggests that the reopening of the Strait of Hormuz will further overheat the economy, forcing the Fed to raise interest rates soon.”

Whether Slok’s view proves correct will take time to assess, as geopolitical tensions and broader macroeconomic uncertainty continue to cloud the outlook. In the near term, however, inflation pressures are still expected to ease somewhat.

The Federal Reserve Bank of Cleveland’s inflation nowcast points to a modest slowdown in year-over-year CPI after several months of elevated readings. Meanwhile, Core CPI — which has remained relatively stable throughout the conflict, rising only slightly — is projected to increase 2.9% in the latest monthly update compared with a year earlier.

Fed funds futures markets are now assigning higher odds of near-term tightening, pricing in a 34% probability of a 25-basis-point rate hike at the next FOMC meeting on July 29, with expectations rising to around 67% in favor of further tightening by September.

Morningstar expects any near-term inflation persistence to gradually fade over time. The firm notes: “We expect inflation to fall in the coming years. Receding energy prices will be reflected in a negative impulse to inflation in 2027. The tariff impact should also cease going forward. Moreover, wage growth has slowed considerably, which should help push services inflation back to normal. Housing inflation also continues to trend down.”

Still, while the longer-term outlook points toward easing inflationary pressure, that horizon remains distant. In the immediate term, markets are taking comfort in signs of cooling prices, though uncertainty around the Federal Reserve’s policy path suggests that current stability may not last.