Investors are increasingly preparing for the Federal Reserve to raise interest rates as oil prices climb, driven by a new round of tit-for-tat attacks between the U.S. and Iran. Brent, the global crude benchmark, hit $100 a barrel on Thursday for the first time since late May, according to CNBC.
Shifting Interest Rate Probabilities
Market expectations for borrowing costs have shifted rapidly. According to CME’s FedWatch tool, fed funds futures are now pricing in a roughly 82% likelihood that the central bank will lift rates at its September policy meeting, up from below 53% a week ago. For the upcoming meeting on July 28-29, the current federal funds rate target remains at 3.5% to 3.75%, where it has been parked since January 2026. While the base case is still to keep rates unchanged, a growing minority is planning for an increase; futures trading indicates a nearly 38% probability of a quarter percentage point hike, compared to less than 12% a week prior.
Other prediction markets show similar trends. Kalshi traders saw the odds of a September quarter point increase rise to 48% midday Thursday, from about 30% a week ago. Polymarket assigns a 49.5% probability of a hike by September and a 64% probability that at least one rate hike will occur in 2026.
Inflation Pressures and Labor Market Strength
The push for higher rates is fueled by inflation concerns and a resilient labor market. The average price for a gallon of gasoline in the U.S. reached $4 this week, the highest in more than a month, per AAA. Federal Reserve Chair biz.heraldcorp.com stated during a July 14 House Financial Services Committee hearing that he would have “no tolerance” for persistently high inflation.
The Fed’s preferred PCE inflation gauge was 4.1% in May, and the “core” rate, which excludes volatile energy, was 3.4%. While consumer price inflation eased to 3.5% last month, it remains well above the Fed’s 2% target. Additionally, employment data suggests the Fed can focus more on inflation than labor market health; initial jobless claims dropped to 187,000 for the week ended July 18, the fewest claims since 1969.
Market Volatility and Economic Impact
The prospect of tighter monetary policy has created a perfect storm of headwinds,
according to Larry Tentarelli, chief technical strategist at the Blue Chip Daily Trend Report. This has contributed to a downward trend in the stock market, with the Dow Jones Industrial Average tumbling about 500 points and the Nasdaq Composite shedding more than 2% on Thursday.
Bond markets have also reacted to the volatility:
- The 2-year U.S. Treasury yield rose about 5 basis points on Thursday, remaining elevated at 4.14% as of Tuesday.
- The benchmark 10-year US Treasury note hit its highest level in 18 months.
- 10-year yields in France and Germany reached 15-year highs.
Analyst Outlook
Opinions vary on the timing of the next move. James Bullard, a former president of the St. Louis Fed, suggested that while July might be too soon, a tightening cycle
involving more than one hike could begin in September. Mark Cabana of Bank of America told the Financial Times that the July meeting is “clearly live.”
However, some long-term forecasts remain more dovish. According to FactSet, the consensus forecast among economists is that the Fed will not hike rates this year, with expectations that the central bank will lower borrowing costs by half a percentage point in 2027.
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