Markets raise chances for a Fed rate hike following hot inflation report

Traders shifted their expectations on Tuesday away from anticipating any Federal Reserve interest rate cuts, with a higher probability now being placed on a potential hike. This change came following a report showing higher-than-expected inflation, which led market pricing to rule out any chance of a rate cut through the end of 2027.

According to the CME Group’s FedWatch tracker, there is now a better than 1-in-3 chance of an interest rate hike by the end of this year. This shift in expectations is driven by concerns over rising costs of living outweighing worries about the labor market’s stability. Mark Zandi, chief economist at Moody’s Analytics, believes that if inflation expectations continue to rise, the Fed may start raising interest rates instead of cutting them.

While consumer surveys have indicated elevated inflation expectations, market-based measures have been relatively stable. However, since the start of the Iran war, derivative contracts have been on the rise, reaching levels last seen in 2025. The surge in energy prices due to the conflict has contributed significantly to the recent spike in the consumer price index, reaching its highest level in almost three years.

Market pricing now implies a 37% probability of a rate increase before the year ends. This hawkish outlook presents a challenge for incoming Fed Chair Kevin Warsh, who has expressed support for rate cuts. President Donald Trump, on the other hand, has been vocal about his expectations for a more accommodative central bank.

Despite the recent inflation spike driven by energy prices, some analysts believe that the impact on the overall economy is limited. Raymond James chief economist Eugenio Aleman pointed out that when excluding food, energy, and shelter costs, the April increase was much smaller. Jefferies economist Thomas Simons also noted that there is little evidence of the energy inflation spreading throughout the economy.

While the chances of a rate cut this year are diminishing, there are still expectations that the next move in policy rates will be a cut rather than a hike. As the Fed continues to monitor economic developments, the path forward remains uncertain.