Soaring oil prices = hawkish Fed? Bank of America: The market may have misjudged and the 2022 script will be difficult to repeat

# Zhao Ying

Source: Wallstreetcn

Bank of America Merrill Lynch issues warning: Markets are making a **dangerous logical mistake**—interpreting rising oil prices directly as a hawkish signal from the Fed. A supply-side shock suppresses growth and lifts inflation at the same time, spreading policy risks to **both ends** rather than a one-sided hawkish tilt. With a soft labor market and mild inflation, the current environment is nothing like 2022. If the oil price shock persists, the Fed is **more likely to turn dovish**.

Rising oil prices do not necessarily mean the Federal Reserve will turn hawkish, as Bank of America Merrill Lynch warns the market is misreading the Fed’s policy response.

Since the outbreak of the Iran conflict, 2-year U.S. Treasury yields have climbed in lockstep with oil prices, with markets pricing the supply-side shock directly as a signal of tighter monetary policy.

In its morning market note released on March 10, BofA Merrill Lynch says this logic is fundamentally flawed: a supply shock threatens **both sides** of the Fed’s dual mandate, widening uncertainty over the policy path in **both directions**, not just a one-sided hawkish shift.

Aditya Bhave, U.S. economist at BofA Merrill Lynch, points out that the current macro backdrop is **dramatically different** from 2022—a softer labor market, mild inflation, and limited fiscal stimulus. If the oil price shock persists, the Fed’s response is more likely to be dovish, rather than a repeat of the aggressive rate-hike path seen in 2022.

### Markets price higher oil as a purely hawkish signal

Since the Iran conflict began, 2-year U.S. Treasury yields have moved closely with WTI crude prices. The implicit market logic is: rising oil boosts inflation expectations, forcing the Fed to keep rates high or even resume hikes. The only exception came on Friday after weak February nonfarm payroll data, when yields briefly decoupled from oil.

BofA Merrill Lynch argues this pricing ignores the **dual nature** of a supply shock. A supply-side shock pushes up inflation while also weighing on economic growth and employment, creating conflicting pressures on the Fed’s dual mandate—price stability and full employment.

This pressure fattens the “tails” of the policy distribution: the probability of an extended rate pause rises, the tail risk of a rate hike remains, but the risk of a substantial rate cut is equally notable.

### Why the 2022 playbook is hard to repeat

BofA Merrill Lynch emphasizes that the right-tail policy risk (the Fed turning hawkish on higher oil) only holds if demand is strong enough to absorb the supply shock without a significant slowdown, allowing the Fed to focus on inflation. That condition was met when the Russia-Ukraine war erupted in 2022: unemployment below 4%, core PCE inflation above 5%, monthly nonfarm payroll gains of roughly 500,000, and consumers sitting on large pandemic-era savings.

The current environment is a stark contrast. BofA notes the labor market is soft, inflation is only moderately elevated, and fiscal support is relatively limited. In this context, a persistent oil shock makes a dovish Fed response **more likely**, not tighter policy as markets expect.

### Policy uncertainty widens to both ends

BofA Merrill Lynch’s core judgment: higher oil “fattens the tails of the policy distribution” rather than shifting probability mass unilaterally toward hawkishness. Specifically, the chance of an extended rate pause rises; hiking remains a tail risk, but the risk of deep rate cuts also increases if the supply shock drags down growth.

Today’s macro fundamentals mean the Fed’s sensitivity to oil shocks is nothing like 2022. If markets continue using the old playbook, they risk a major directional misjudgment.

On the macro data front, BofA Merrill Lynch cut its Q1 GDP tracking estimate from 3.3% to 2.9% (quarter-over-quarter annualized), mainly due to weaker-than-expected January retail sales and February nonfarm payrolls. Personal consumption expenditures tracking was lowered from 2.2% to 1.8%, and residential investment from 1.5% to 1.0%.

## Risk Warning and Disclaimer

The market involves risks; investing requires caution. This article does not constitute personal investment advice and does not take into account individual investors’ specific investment objectives, financial situations, or needs. Investors should consider whether any opinions, views, or conclusions in this article are appropriate for their particular circumstances. Any investment made in reliance on this article is at your own risk.