A customer shops for produce in an H-E-B grocery store on May 11, 2026 in Austin, Texas.
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Traders moved further away Tuesday from expecting any Federal Reserve interest rate cuts and in fact began anticipating a higher probability that the next move would be a hike.
Following a hotter-than-expected inflation report, market pricing took virtually any chance of a cut off the table between now and the end of 2027, according to the CME Group’s FedWatch tracker of 30-day fed funds futures contracts.
Instead, they priced in a better than 1-in-3 chance of an increase by the end of this year, as expectations rose that cost of living concerns would outweigh any worries about the labor market deteriorating.
“At this point, I suspect they just stay on hold,” Mark Zandi, chief economist at Moody’s Analytics, told CNBC. “The deciding factor for the Fed will be inflation expectations, if they do continue to move higher … If they break out any further, I think at that point the Fed will likely focus on inflation and start raising interest rates as opposed to cutting them.”
While consumer surveys have indicated elevated inflation expectations, market-based measures had been mostly benign.
However, since the Iran war began, derivative contracts — known as “forwards” — have been climbing higher and most recently were hovering around levels last seen in the autumn of 2025.
Since the fighting began in late February, energy prices have been soaring, accounting for more than 40% of a gain in the consumer price index that sent the headline inflation level to its highest in nearly three years, according to a Bureau of Labor Statistics report Tuesday.
Market pricing around noon Tuesday implied about a 37% probability of a rate increase before the end of the year.
The hawkish market expectations pose a particular challenge for incoming Fed Chair Kevin Warsh, who is expected to take the reins later his month. Warsh has been outspoken in favor of cutting, and President Donald Trump has been equally vocal about his expectations for an easing central bank.
“I just don’t see how he’s going to get any kind of support for cutting interest rates in the current environment,” Zandi said of Warsh. “If [inflation expectations continue] to move higher, and they are drifting higher, it’s going to be tough. Not only cutting rates will be off the table, but even holding rates where they are is going to be pretty tough.”
To be sure, some Wall Street commentary Tuesday stressed the importance of the energy shock on the CPI data.
Raymond James chief economist Eugenio Aleman said the April increase was much smaller when stripping out food, energy and shelter, the latter of which rose 0.6%, its biggest monthly increase since September 2023.
Similarly, Jefferies economist Thomas Simons noted that there is still only slight evidence that the energy inflation spike is spreading through the economy. At the least, Simons expects the Fed to stay on hold as it watches events unfold.
“As time goes by, the chances of a rate cuts at any point this year are fading, but we still expect that the next move in policy rates is going to be a cut rather than a hike,” Simons said in a note.
