The Iran War Has Put A Fed Rate Hike Back On The Table

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Financial markets are now pricing in a greater probability that the Fed’s next move will be a rate hike rather than a cut.
The Iran war has driven up energy prices, putting pressure on the Fed to stamp down inflation with higher interest rates.
The Fed also has reason to go the opposite way and lower rates to boost the economy with cheaper loans and prevent the job market from collapsing.

The Iran war has turned the outlook for borrowing costs on its head.

For the first time in years, financial markets were pricing in a greater likelihood that the Fed’s next move would be to raise its benchmark interest rate sometime in the next three months, rather than cut it, according to the Federal Reserve Bank of Atlanta’s market probability tracker. There was a 25% chance of a rate hike versus a 20% of a cut on Tuesday, according to the tracker, which forecasts rate movements based on trading data from the CME group and the New York Fed.

A rate hike has gone from unthinkable to more likely than a cut, as the Iran war has stoked inflation fears.Credit: Investopedia / Federal Reserve Bank of Atlanta — A rate hike has gone from unthinkable to more likely than a cut, as the Iran war has stoked inflation fears.
Credit: Investopedia / Federal Reserve Bank of Atlanta

That’s a sharp reversal from the eve of the Iran war, when a rate cut was priced at 40% and a hike was given a remote 5% chance. Previously, the Fed had been widely expected to cut its key interest rate to lower borrowing costs across all kinds of loans and boost the faltering job market.

But the Iran war has sent energy prices soaring, and could drag inflation along with it. That has raised the chances that the Fed will have to hike rates to quash inflation as it pursues its dual mandate from Congress to keep employment high and inflation under control.

Higher interest rates could slow the economy at a time when economic growth was already being held back by tariffs and higher prices.

More likely than either a hike or a cut, the Fed is expected to keep its key interest rate on hold to give policymakers a chance to see how the war affects the U.S. economy. The Fed’s next decision is on Wednesday, and financial markets are overwhelmingly signaling an expectation of the rate staying flat.

The Fed had hiked rates from near-zero between 2022 and 2023 to suppress the post-pandemic spike in inflation. Since 2024, every rate movement has been a cut.

Read the original article on Investopedia