The market has turned decidedly more bearish in its outlook for interest rates, with the possibility of a rate hike steadily edging higher in recent weeks.
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The odds that the Federal Reserve will hike rates instead of issuing more cuts in 2026 have shot up, a sign that investors are growing increasingly anxious about upside risks to inflation.Markets are worried that the recent spike in oil prices could boost inflation, leading the Fed to tighten monetary policy to get price growth under control. That could sour the outlook for stocks and other risk assets, given that investors have been betting on rate-cuts as a bullish catalyst for most of the past year.The Fed opted to keep rates unchanged at its last policy meeting, with the central bank’s target rate range remaining at 3.50%-3.75%. But the priced-in probability that the Fed could lift rates at least once before the end of the year jumped to 10% shortly after Fed Chair Powell’s press conference, up from 0% a day earlier. The odds that the Fed could hike rates at least 25 basis points pared back slightly heading into the weekend, but surged again on Monday, according to the CME FedWatch tool. Meanwhile, the odds of even one Fed cut through the rest of the year have tumbled.
Shortly after the Fed’s policy meeting on April 29, Powell said he believed the Fed should adopt a neutral policy stance, but warned that prices could “go much higher” the longer the Iran war lasts.Oil prices, meanwhile, got a big lift on Monday, fanning inflation concerns. Brent crude, the international benchmark, climbed nearly 6% by mid-day.Other indicators are also flashing signs that rate hikes could be looming. One key indicator of traders’ short-term expectations for bond yields has turned positive for the first time since 2022, global markets strategists at JPMorgan wrote on Friday.Previously, markets were showing signs that investors believed the downside risk to the job market would “outweigh inflationary concerns for much of 2026,” which would position the Fed more favorably to cut rates, the bank added.”Looking ahead, we think risks remain skewed towards higher yields, particularly in the wake of the FOMC meeting,” the strategists wrote.The 5-year breakeven inflation rate — a reflection of expected inflation 5 years from now in the US Treasury market — climbed to 2.69% on Friday, its highest level since 2023, DataTrek Research said in a note.”5-years are saying the Fed needs to hike, and soon,” Nicholas Colas, DataTrek’s co-founder, wrote in a note on Monday.Economists at Macquarie Research said they believed the Fed’s next move would most likely be to hike rates early next year, citing expected resilience in the US job market.”While the outlook remains uncertain, our baseline remains that the next Fed rate change will be a hike (in 1H27) with broadening evidence of labor market improvement a key reason,” the financial firm said.