Rate Cut Expectations Plummet as Energy Prices Surge Amidst Escalating Middle East Tensions

Washington D.C. – The Federal Reserve’s anticipated pivot to interest rate cuts is facing significant headwinds as a confluence of surging energy prices and resurgent inflation fears has dramatically altered market expectations. Traders, once optimistic about an early summer easing, have largely abandoned these hopes, a sentiment shift that has coincided with a sharp escalation in oil prices, reportedly reaching around $100 a barrel, following U.S.-Israel attacks on Iran.

Prior to this geopolitical flare-up, market sentiment, as gauged by CME Group’s FedWatch tool, leaned towards a quarter percentage point rate reduction in June, with a strong possibility of a second cut in September. Some analysts even entertained the prospect of three rate decreases by the end of 2026, contingent on economic performance. This optimistic outlook was underpinned by expectations of a cooling labor market, moderating inflation, and the anticipated dovish stance of a new Federal Reserve Chair set to take office in May. However, the unfolding "Iran drama," as it’s being termed, has firmly re-established inflation control as the paramount concern for the central bank.

Goldman Sachs economists, in a note released on Wednesday, articulated this shift, stating, "A higher inflation path will make it harder for the Fed to start cutting soon." Consequently, the firm has officially revised its rate forecast, pushing back its projected first rate cut to September from June. Despite this adjustment, Goldman Sachs economists maintain that the Fed could still implement one additional rate reduction before the close of 2026, particularly if the labor market weakens more substantially and sooner than currently anticipated. They further noted that concerns about the impact of higher oil prices on inflation and inflation expectations would not necessarily impede earlier rate cuts if labor market weakening becomes a dominant factor.

However, not all market participants share this degree of optimism. Traders in the fed funds futures market have gone further, effectively removing a September rate cut from their calculus. Their current expectations point to a single rate cut, anticipated in December, according to the CME gauge. The market is now pricing in no further rate reductions until well into 2027, or even the early part of 2028. This outlook persists despite the impending arrival of presumptive new Chair Kevin Warsh, a nominee by President Donald Trump who has been characterized by his willingness to ease monetary policy aggressively. Current Chair Jerome Powell is scheduled to depart the position in May.

The trajectory of future rate decisions is intricately linked to the unfolding situation in the Middle East. A de-escalation of tensions could usher in a renewed sense of market normalcy and rekindle hopes for more significant monetary easing.

Even as Brent crude prices remained above the $100 mark, President Trump reiterated his calls for the Federal Reserve to lower interest rates. Trump took to his social media platform, Truth Social, to state, "Where is the Federal Reserve Chairman, Jerome ‘Too Late’ Powell, today? He should be dropping Interest Rates, IMMEDIATELY, not waiting for the next meeting!"

The Federal Reserve will have another opportunity to assess inflation dynamics on Friday morning with the release of the personal consumption expenditures (PCE) price index data for January, provided by the Commerce Department. Economists surveyed by Dow Jones anticipate that core PCE, a key metric closely watched by Federal Reserve officials, will register an increase to an annual inflation rate of 3.1%. This projected figure represents a 0.1 percentage point rise from December and a further deviation from the Fed’s 2% target. Such a reading would underscore that inflationary pressures were building prior to the recent strike in Iran, potentially reinforcing the Federal Reserve’s caution regarding the prospects for lower interest rates.

Stephen Juneau, an economist at Bank of America, noted in a recent report that while certain critical components of inflation, notably housing, are exhibiting signs of stabilization or decline, inflation in other areas has remained "rangebound and remains above levels consistent with 2% core PCE." Juneau concluded that "The upshot is that the Fed should not be in a rush to ease rates further."

The Federal Open Market Committee (FOMC), the Fed’s rate-setting body, is scheduled to announce its next interest rate decision on March 18. Current market pricing indicates an almost certain probability of the committee maintaining its current policy stance and keeping rates on hold.

The image accompanying this report depicts U.S. Federal Reserve Chair Jerome Powell reacting during a press conference following a two-day meeting of the Federal Open Market Committee (FOMC) on interest rate policy, in Washington, D.C., U.S., on January 28, 2026. The photograph was taken by Jonathan Ernst for Reuters.