As Fed Holds Steady, Oil Spike Has 2026 Rate Cut Expectations Shrinking Fast

Amid the ongoing Iran war, Federal Reserve Chair Jerome Powell was entirely uninclined to speculate on the trajectory of energy prices. But in the markets, expectations for interest rate cuts are being scaled back.

As widely expected, the Fed opted to keep interest rates at the current target range of 3.50%-3.75%. The central bank has been on pause since its last cut in December 2025. Over September 2024 to December 2025, the Fed cut rates by 1.75 percentage points altogether.

The federal-funds rate is still significantly above the pre-pandemic (2017-19) average of 1.7%. And most believe the long-run neutral level, at which rates neither stimulate nor restrict the economy, is below the current level (the FOMC’s assessment of the neutral rate is about 3%). Thus, at the start of this year, most believed the Fed was not done cutting.

However, the staggering rise in oil prices following the onset of war in the Middle East has put rate cuts on an indefinite pause. We expect overall PCE inflation to accelerate to 3.5% year over year by April, up from 2.8% in January and the highest mark since May 2023.

Futures markets now imply only one rate cut in 2026, compared with two cuts before the war. In the latest meeting, the median FOMC participant predicted one cut in 2026, unchanged from the December projections. But this was already somewhat cautious compared with the market-implied two cuts, and we see several participants have changed their individual expectations.

Federal Funds Rate: Historical Data and FOMC Projections

Each dot represents one FOMC member’s federal funds rate forecast for the end of 2026.

In the December projections, eight participants called for two or more cuts in 2026, but that’s now down to five. Even Stephen Miran, who was likely the participant previously calling for a whopping six cuts in 2026 (in deference to President Trump), seems to have trimmed his expectation to four cuts.

This may indicate the Fed is inching in a hawkish direction. Indeed, as of this afternoon, futures markets imply about a 48% probability of no rate cut in 2026, up from 30% yesterday. However, today also saw adverse inflation news via the Producer Price Index, as well as another uptick in oil prices.

There are a wide range of outcomes for the Iran war, its impact on oil prices, and how that impacts the US economy. Powell refused to speculate what the central bank would do in various scenarios. Could it hike interest rates? He certainly didn’t rule it out. The Fed’s default view is that the energy shock is a onetime uplift to inflation. However, if the spike in oil prices lasts longer than expected, the Fed could be forced to hike rates.