How everything can change in an instant! Just a month ago, the futures market was pricing in two quarter-percentage point interest rate cuts by the Federal Reserve by the end of 2026. And based on futures prices, there was a growing possibility that the Fed could cut three times, as I wrote on February 21.
Today, however, the futures market sees a nearly 80% chance (78.2% to be exact) that the Federal Reserve will not make any cuts to its target interest rate this year. A month ago, futures traders estimated the chances of the Federal Reserve not cutting any cuts this year were just 5.3%.
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And Bloomberg reports that bond traders are also not pricing in any Fed rate cuts this year. This can be seen by how two-year Treasury yields are moving, which are extremely sensitive to expectations about Federal Reserve policy. The two-year yield is suddenly trading above the Federal Reserve’s effective funds rate, suggesting that the bond market is not expecting cuts from the Federal Reserve any time soon.
Why such a big change in expectations about Federal Reserve cuts? Basically, it is due to the war in Iran and its impact on oil prices (Brent crude oil is now about 50% higher than just before the war started). The Federal Reserve and other central banks need some clarity about where the economy is headed when they set monetary policy. Right now they don’t have any.
When asked about the impact of the oil shock on the economy and the outlook for interest rates, Powell basically threw up his hands in frustration. “What I really want to emphasize is that no one knows,” he said at the news conference that followed the release of the latest political statement on Wednesday. “The economic effect could be larger, it could be smaller, it could be much smaller or much larger. We just don’t know.”
If the bond and futures markets are right, and the Federal Reserve sits idly by for the rest of the year instead of lowering interest rates, it will be a disappointment for investors.
If you’re not familiar with the well-known phrase “Don’t fight the Fed,” it’s basically an acknowledgment that when the Fed lowers rates, investors can and should assume that will drive the market higher, and they should invest accordingly.
Just a month ago, it looked like the stock market would enjoy a strong rate cut tailwind in 2026. Unfortunately, the war has eliminated that expectation.