The Fed is going hiking

It’s hiking season again. And no, not just because it’s springtime.

For months, traders were betting that the Fed would keep rates steady amid the war in Iran and fears of stagflation. But now that pendulum has swung in the other direction: As of this morning, traders in the futures market believe there’s a 52% chance that the Federal Reserve will raise interest rates by the end of 2026—the first time the probability has crossed the 50% threshold.

The reason, of course, is spiking energy prices. While inflation is still well above the Fed’s 2% target, global benchmark crude oil prices just surpassed $110, putting even more inflationary pressure on the economy. That isn’t going to end anytime soon: Just yesterday, the Organization for Economic Cooperation and Development said it expects headline inflation in the US to rise from 2.6% last year to 4.2% through the end of this year.

There’s the stag, then the ’flation

We’re already seeing the downstream effects of higher energy prices, such as major retailers warning they may be forced to raise prices due to higher transportation costs. Meanwhile, the Bureau of Labor Statistics said yesterday that import prices jumped 1.3% in February—the metric’s largest monthly spike since March 2022, mostly due to rising fuel costs.

It’s not just inflation that remains a problem: the OECD expects economic growth to slow this year as well. And the final part of the stagflation puzzle—the labor market—remains locked in purgatory as job growth trickles while unemployment remains stable.

The Fed’s biggest question mark yet

The threat of stagflation puts central bank officials between a rock and a hard place. On one hand, if they raise rates, it could mitigate rising inflation, but cause the economy to slow so much we fall into a recession. If they keep rates steady for the next year, or even cut them, inflation could spiral out of control again, 2022-style.

Back in March, Fed officials reiterated their consensus of one rate cut this year. The next FOMC meeting is in April, and right now, traders are pricing in a 95% chance rates will be kept the same.

In a speech yesterday, FOMC Vice Chair Philip Jefferson noted that the current economic pressure “complicates, at least in the short term, the picture on both sides of our dual mandate.” That might be the understatement of the year.—LB