(The opinions expressed here are those of the author, a

columnist for Reuters.)

By Jamie McGeever

ORLANDO, Florida, March 25 (Reuters) - Markets

overshoot, and the dramatic surge in bets on higher interest

rates in light of the Middle East energy shock is the latest

case in point: the move may be logical, but its magnitude is

questionable.

As the dust settles on one of the busiest central bank weeks

in years, the Iran war shows no sign of ending and markets

remain in flux. It may be time for rates traders to take a

breath and reevaluate.

The sudden change in the global rate outlook clearly

reflects fears about the near-term impact of soaring oil and gas

prices on inflation. The Federal Reserve is now more likely to

raise U.S. rates this year than cut them, while the European

Central Bank and Bank of England are now predicted to hike

multiple times, possibly starting as early as next month.

The shift in Europe is worth zooming in on.

On February 27, the day before the joint U.S.- Israeli

strikes on Iran, UK rates futures pointed to 50 basis points of

easing by year end, or two quarter-point rate cuts. That has now

flipped to almost 75 basis points of tightening, or three hikes.

A 125-basis point swing in a matter of weeks is

extraordinary.

Meanwhile, euro zone rates futures have gone from implying

that the ECB will keep its key policy rate on hold at 2% for the

rest of this year to pricing in two rate hikes.

This hawkish trajectory could come to pass. Policymakers are

still scarred from misreading the "transitory" inflation of

2021-22. But the last two times they raised rates with oil well

above $100 a barrel - in 2008 and 2011 - they were widely

accused of policy mistakes.

LIMITS OF 2022 COMPARISONS

Many analysts are drawing parallels between now and the

energy shock sparked by Russia's invasion of Ukraine in February

2022 that helped fuel the worst bout of developed market

inflation in decades.

But there are key differences.

Interest rates are significantly higher going into this

crisis than they were in February 2022. At that time, G4 central

bank policy rates were near the zero lower bound, with the ECB

and Bank of Japan in negative territory.

What's more, inflation in 2022 was also being fed by

trillions of dollars of pandemic-fighting stimulus and the burst

of economic activity after lockdowns were lifted. Real interest

rates in early 2022 were deeply negative.

That combination of super-easy fiscal and monetary policy

meant inflation turned out to be far from transitory. In the

U.S., it still hasn't returned to target despite the most

aggressive hiking cycle in 40 years.

Fiscal stimulus is also in the cards today, with governments

from Washington to Tokyo to Berlin set to spend heavily on

defense and energy while slashing taxes. But these volumes will

be nowhere near as big as the pandemic-fighting packages that

were worth at least 10% of GDP.

GOLDMAN, CITI STICK TO U.S. RATE CUT VIEW

Economists at Goldman Sachs and Citi are among the dwindling

band standing against the rising tide of forecast revisions and

calls for the Fed to nip price pressures in the bud with a rate

hike or two.

Jan Hatzius and his team at Goldman are still penciling in

two Fed rate cuts this year, and Citi's Andrew Hollenhorst and

team are sticking to their call for three cuts.

They argue that any incoming inflation burst will be

short-lived, lasting maybe a few months, while the downside

risks to growth and employment will run deeper. In essence, they

anticipate a temporary supply shock that raises prices but deals

a more lasting blow to demand.

There's already reason to believe this could be the case.

Purchasing managers' index data on Tuesday showed that U.S.

private sector output in March fell to its lowest in 11 months,

overall activity in the euro zone fell to a 10-month low, and

activity in Britain expanded at its slowest pace in six months.

Rates markets are right to be on edge given the speed and

magnitude of the energy price shock. Still, it will be difficult

to justify raising rates if growth is slowing and unemployment

is rising, even if inflation is above target, as it is in the

U.S. and Britain.

(The opinions expressed here are those of Jamie McGeever, a

columnist for Reuters)

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