Futures market traders have pushed the probability of a Federal Reserve interest rate increase by the end of 2026 above 50% for the first time, a threshold that signals a genuine shift in how financial markets are reading the US economic outlook. At the start of 2026, those same markets were pricing in roughly two quarter-point rate cuts before year-end. The complete reversal has happened in under three months, driven almost entirely by the inflationary shock from the Iran war and its effect on energy and import costs.
The concern is stagflation, a specific and historically difficult economic condition where inflation rises while growth slows simultaneously. It is difficult because the Federal Reserve's standard tools work against each other in that environment. Raising rates to fight inflation also slows growth further. Cutting rates to support growth risks adding fuel to already-rising prices. The Fed faced exactly this problem in the 1970s, when it took nearly a decade and a severe recession under Fed Chair Paul Volcker to break inflationary expectations.
What changed in the futures markets
The CME FedWatch tool, which tracks the implied probability of Fed rate decisions based on federal funds futures contracts, showed the probability of at least one rate hike by December 2026 crossing 52% on Friday. As recently as February 1, 2026, the same tool showed a 74% probability of at least one rate cut by year-end. That is a swing of more than 125 percentage points in the directional expectation for Fed policy over the course of eight weeks.
The specific catalysts have been sequential. Oil prices broke above $94 per barrel in early March, then crossed $110 as Strait of Hormuz disruptions intensified. Import cost pressures from existing tariffs were already running at elevated levels before the conflict began. February's Consumer Price Index data, released March 12, showed headline inflation at 3.4%, above the Fed's 2% target. The core PCE deflator, which is the Fed's preferred inflation measure, came in at 2.8% year-over-year for February.