Markets Flip From Pricing Cuts To 50% Chance Of Hikes

The Iran conflict has reshaped the narrative in interest rate markets. Since February 27, just before the United States and Israel launched joint strikes, front-end Treasury yields have climbed more than 60 basis points.

Back in February, worries over private credit and AI disruption dominated, fueling speculation of broader contagion to the U.S. economy. But March’s surge in oil prices triggered a global bond sell-off. The move in Treasury yields tracked a sharp repricing of Fed expectations: in late February, markets priced a 96% probability of cuts by the end of 2026, including a 78% chance of two or more cuts. By June 1, that had flipped to a 0% probability of any cut this year and a greater than 50% chance of one or more hikes.

This ultimately comes back to an inflation conversation. The oil spike could prove a temporary supply shock with no lasting impact on growth or inflation trends — provided the conflict resolves quickly and prices fall. The longer energy prices stay elevated, the more likely the effects spread beyond the pump. April’s PPI, for instance, showed an 8.1% jump in trucking freight rates. If that persists, firms will likely raise goods prices to protect margins.

The hawks have ready counterarguments. Higher oil prices aren’t yet captured in a trimmed measure, but they can eventually bleed into the middle 45% of components — as can the secondary effects of steel and aluminum tariffs across manufacturing. Another factor likely still fresh in hawkish memory: the trimmed-mean index lagged core PCE by nearly 2 percentage points in late 2021, just before the Fed had to drop the hammer with 525 basis points of hikes.

An end to the conflict, including a reopening of the Strait of Hormuz, should bring sharp relief in oil prices and ease some — but not all — of these worries. Several Fed officials flagged lingering inflation concerns even before the first missile flew. There’s also the risk of repeated “one-off” shocks becoming entrenched in expectations, a far thornier problem for policymakers.

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Jason Haley joined ALM First in 2008 and is the firm’s chief investment officer. He heads ALM First’s Investment Management Group (IMG), which is responsible for leading the investment process and investment theme development. Haley also oversees all capital markets activities, including portfolio management, trading, market research and commentary, and execution of hedging and funding strategies for the firm’s depository clients. He holds an MBA with a concentration in finance and a BBA with a concentration in marketing, both from The University of Mississippi.

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