Fed plot unfolds

Oil prices ended up more than 3% on Tuesday amid fresh Iranian attacks on Gulf states, but eased early on Wednesday as countries sought alternative routes for oil exports amid the continued blockage in the Strait of Hormuz.

Those routes include pipelines that bypass the strait - notably Saudi Arabia's East-West pipeline to the Red Sea - as well as Turkey's Ceyhan port, where exports will be resumed after a deal was struck between the Iraqi government and Kurdish authorities.

But the scramble for alternatives also shows that exporters see little chance of a swift end to the conflict or a resumption of normal flows. Reflecting that, Brent crude remains elevated above $100 per barrel, where it's settled for four consecutive sessions.

Indeed, the war rages on, with Iran's security chief Ali Larijani killed yesterday by an Israeli strike, tit-for-tat attacks continuing across the Middle East, and the Trump administration seeing its first high-profile resignation over the war.

Nevertheless, global stocks have taken heart at the marginal reduction in oil price volatility. U.S. stocks finished higher on Tuesday, with all major indexes eking out slight gains, while Asian shares rallied on Wednesday. U.S. stock futures were in the green ahead of the bell.

Meantime, the dollar eased on the slight risk-on turn yesterday, shedding some of its gains since the start of the war but remaining around 1.5% higher overall against a basket of major currencies.

In tech, anxiety about a global chip shortage is adding to inflation worries - but the AI boom will still muscle its way back into the picture later today as U.S. memory chipmaker Micron Technology reports earnings.

Returning to central banks, while the Fed is expected to stand pat on rates today, perhaps the bigger takeaway will be officials' commentary around how the Iran war might reshape the U.S. economic picture.

Elsewhere, traders will also hear from the Bank of Canada as it issues its own rate decision today, while the Bank of Japan is set to begin its two-day monetary policy meeting.

With that, onto today's column.

Central banks have good reason to sit up and take notice of how this month's oil shock is hitting inflation expectations. Yet financial market pricing shows a split picture so far. It looks like a one-two punch: a near-term cost-of-living burst that subsides again over the longer term.

The core debate in a week packed with major monetary policy meetings is whether an inflation spurt warrants interest rate rises - or whether central banks should treat the Iran-related ‌energy supply shock as temporary and focus instead on its parallel drag on demand.

Graphics are produced by Reuters.

Graphics are produced by Reuters.

The Fed's focus on Wednesday will be on how it signals future policy caution around this month's oil shock. But in the background, investors will be asking how a new chair might change the central bank's approach later this year, not least given current nominee Kevin Warsh's views on reducing the Fed's balance sheet.

One way to engineer that could be to concentrate more of the Fed's Treasury holdings in short-term bills that can then be more easily allowed to roll off as they mature. A more bill-heavy maturity profile is already slowly emerging.

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