Fed Holds Rates, but Markets Start Pricing a New Risk: the Next Move Could Be a Hike

The Federal Reserve did exactly what Wall Street expected this month: it left interest rates alone. What investors did not expect was what happened next.

In the days after the Federal Open Market Committee kept its benchmark federal funds target at 3.50% to 3.75% on March 18, futures markets quietly rewrote the interest-rate outlook. After two years of arguing over how many cuts the Fed would deliver, traders for the first time in this cycle began to price in a serious chance that the central bank’s next move will be a rate increase, not a reduction.

The shift reflects a new source of uncertainty hanging over the U.S. economy: a war in Iran that has choked a vital oil shipping lane, sent crude prices to their highest levels in more than a decade and revived concerns that inflation could stay elevated longer than policymakers had hoped.

The Federal Reserve, for its part, still projects that its next step is more likely to be a cut. But its language and internal forecasts, combined with the energy shock, have pushed investors toward a “higher for longer” view of borrowing costs—and, for the first time in this cycle, toward treating a hike as a nontrivial risk.

“It is a highly uncertain environment,” Chair Jerome Powell said at his March 18 news conference. “The implications of developments in the Middle East for the U.S. economy are uncertain.”

He added that the recent spike in oil prices was “a material part of the higher inflation forecast” for 2026, though “not the whole story.”

A hold that sounded more hawkish

The FOMC voted 11–1 to keep the target range unchanged, with Governor Stephen Miran dissenting in favor of a quarter-point cut. The post-meeting statement described economic activity as “expanding at a solid pace” and noted that unemployment had changed little in recent months. It also said inflation “remains somewhat elevated” and emphasized that “uncertainty about the economic outlook remains elevated.”

For many investors, the more important clues came from the Fed’s latest Summary of Economic Projections, including its so-called dot plot of policymakers’ rate expectations.

The median official still anticipates one 25-basis-point cut this year and another in 2027, leaving the longer-run “neutral” rate estimate at 3%. But the distribution of views has shifted. Several officials who previously penciled in two cuts for 2026 now foresee only one, and a larger bloc sees no cuts at all. At least one policymaker now projects a rate hike instead of a reduction—the first such hawkish dot in roughly two and a half years.

The projections were pulled together under unusually challenging circumstances. Powell said Fed staff had even considered skipping the forecast exercise altogether because the range of potential outcomes from the conflict was so wide.

“Nobody knows with any confidence how this situation will evolve,” he said. “We decided in the end that it was still useful to provide a baseline, but it comes with a great deal of uncertainty.”

Powell repeated that the Fed’s 2% inflation target remains nonnegotiable and described current policy as “at the high end of neutral or mildly restrictive.” He also stressed that the projected cut this year is conditional on continued progress in cooling underlying price pressures.

“If this progress on underlying inflation doesn’t show up,” he said, “that cut would not be delivered.”

Futures flip from cuts to hike risk

Before the meeting, futures data suggested a near-consensus view that the Fed would stand pat in March and start easing later this year. On March 7, the CME’s FedWatch tool put the odds of no change at the March meeting at about 96%, with a small chance of a cut and essentially zero probability of a hike. Traders were focused on whether the central bank would lower rates once or twice in 2026.

By the time the dust settled after the March 18 decision and Powell’s news conference, that debate had shifted. Market pricing for the June FOMC meeting moved decisively away from an early cut, and expectations for the total amount of easing this year shrank to roughly one quarter-point move pushed further into the calendar.

Estimates compiled from futures prices showed the probability that the fed funds rate would remain at 3.50% to 3.75% by the June 17 meeting climbing to just over 80%, up from about 58% a week earlier and roughly 37% a month earlier. In effect, the near-term path toward cuts that markets had been counting on was priced out.

The change became more striking in the days that followed. By March 24, traders were assigning “meaningful odds” to the possibility that the next change in rates is upward, according to one widely cited analysis of futures data. Market-implied probabilities suggested roughly a one-in-four chance that the policy rate would end the year above its current level, compared with no such probability a week earlier.

That repricing has been echoed in the Treasury market. Yields on the 10-year note, which had risen ahead of the meeting on the back of hotter wholesale inflation data and rising oil prices, hovered around 4.2% to 4.4% in the days afterward. The U.S. yield curve—inverted for much of the past two years—has shifted into a more traditional upward slope as longer-term yields climb relative to short-term ones, reflecting expectations of firmer inflation and fewer, later cuts.

The adjustment has not been confined to government debt. Yields on investment-grade and high-yield corporate bonds have drifted higher in tandem with Treasurys, and risk premiums on lower-rated “junk” debt have widened. Analysts say markets are simultaneously pricing more persistent inflation and a greater risk that tighter financial conditions could tip the economy toward a downturn.

Stocks slide, the dollar climbs

Equity investors have felt the shift. Major U.S. stock indexes fell on March 18 as traders digested the Fed’s message against a backdrop of rising oil and inflation worries. The tech-heavy Nasdaq 100 closed down about 0.5% that day, with market commentary pointing to higher bond yields and fragile sentiment as key drivers.

Losses extended in the following week as the Iran conflict dragged on, oil remained elevated and investors further pared back their rate-cut expectations. By late March, major averages had slipped into correction territory from earlier highs. Strategists warned that an energy-driven slowdown could weigh more heavily on U.S. households and businesses than in past oil shocks, given the combination of high leverage, elevated housing costs and lingering price pressures.

Currency markets moved in the opposite direction. Perceptions of a “less dovish” Powell helped push the U.S. dollar index back toward 10-month highs as traders marked down the odds of near-term easing and pushed out the likely start date for any rate cuts. A stronger dollar tightens financial conditions globally, raising the burden on borrowers with dollar-denominated debts and making dollar-priced commodities like oil more expensive for many countries.

A war half a world away, felt at the pump

The catalyst for the rethink is thousands of miles from Washington.

The Iran war erupted in late February after U.S. and Israeli strikes on Iranian military and energy infrastructure, including the Kharg Island oil terminal and later the South Pars gas field. Iran and allied forces responded by disrupting shipping in the Strait of Hormuz, a narrow waterway through which roughly one-fifth of the world’s traded oil typically passes.

Brent crude quickly shot above $100 a barrel and has traded as high as the $120s in early March, the highest levels in more than a decade. Natural gas prices in Europe have jumped on fears of damage to Iranian supply, and analysts have warned that fertilizer costs could rise, adding pressure to global food prices.

In the United States, gasoline and diesel prices climbed sharply in roughly two and a half weeks. That feedthrough into transportation and distribution costs is expected to lift headline inflation readings in the near term, even if underlying measures that strip out food and energy continue to ease.

Normally, central banks try to “look through” short-lived swings in energy prices, especially when longer-term inflation expectations are stable. Powell acknowledged that doctrine but suggested the situation is different after a series of supply shocks—the pandemic, trade tariffs and now war—and five straight years in which inflation has run above the Fed’s 2% goal.

“At some point, if you keep looking through one shock after another, people may begin to question whether you are really committed to your target,” he said.

Household squeeze and political pressure

The combination of higher fuel costs and a Federal Reserve in no hurry to cut rates has sharpened the financial squeeze on many households.

Mortgage rates, which track longer-term bond yields more closely than the Fed’s benchmark, have edged higher again after falling late last year. That has further eroded affordability for prospective homebuyers, especially younger households and first-time buyers. Credit card and auto loan rates, already near multi-decade highs, show little sign of easing.

Because energy spending and interest payments make up a larger share of budgets for low- and middle-income families, the shock is regressive. Rural residents and commuters who depend on cars, truck drivers and farmers who use large amounts of fuel and fertilizer are especially exposed.

The policy choices facing the Fed are also unfolding in a charged political environment. Former President Donald Trump has publicly urged the central bank to cut rates more quickly, arguing that high borrowing costs are hurting growth. At the same time, Powell is leading the institution while under a Justice Department investigation related to separate matters, a backdrop that has fueled debate over the Fed’s independence even as officials insist decisions are driven solely by the dual mandate of maximum employment and stable prices.

What comes next

Much now hinges on how the war and its economic fallout evolve.

If disruptions in the Persian Gulf ease and oil prices retreat, the energy-driven bump to inflation could prove transitory. In that scenario, and if measures of underlying price growth continue to drift lower, the Fed’s baseline path of at least one cut later this year could materialize, and markets might shift back toward a gentler easing cycle.

If the conflict persists, keeping crude elevated and feeding through to broader prices, the central bank may find it harder to deliver any cuts at all—and could ultimately be forced to raise rates further to maintain its inflation-fighting credibility. Futures markets are now assigning a probability to that outcome that did not exist before the March meeting.

For now, Fed officials are signaling patience. They say they will “carefully assess incoming data, the evolving outlook, and the balance of risks” and stand “prepared to adjust the stance of monetary policy as appropriate”—language that leaves the door open to both cuts and hikes.

The repricing since March 18 underscores that even a decision to stand still can have far-reaching effects when the backdrop is shifting rapidly. Without moving its policy rate by a single basis point, the Fed—and the war in Iran—have helped push up yields, strengthen the dollar and tighten credit as investors start to contemplate a possibility they had largely set aside: that in the next chapter of this cycle, rates might go up before they come down.