10.08.202611:59 Forex Analysis & Reviews: Rate cut hopes fade

For months, Wall Street has been entirely focused on one key question: exactly how many times will the Federal Reserve cut interest rates this year – two, three, or more? Investors and analysts have meticulously parsed every Fed Chair Jerome Powell speech for signals of imminent monetary easing. However, the latest US Bureau of Labor Statistics inflation report has completely upended market discourse and forced market participants to brace for the opposite scenario.

According to the data, the Consumer Price Index rose by 0.6% in April, following March's 0.9% surge. On an annual basis, inflation accelerated to 3.8%, the highest reading since May 2023. Instead of the anticipated cooling, the US economy is showing a renewed inflationary flare-up. As a result, the scenario in which the Fed is forced not to cut but to raise rates again no longer appears far-fetched. This poses a fundamental threat to financial markets that have priced in an era of cheap money and easy financial conditions.

Even potential personnel changes at the central bank's helm are losing their former significance. Donald Trump has repeatedly criticized Powell for being slow to cut interest rates, while his likely candidate for Fed chair, Kevin Warsh, had been viewed by markets as a proponent of more aggressive stimulus. However, rising prices leave the regulator with diminishing room for maneuver. Data from the Kalshi prediction exchange shows a rapid repricing of risks: the probability of a Fed rate hike by the end of 2027 has already reached 27% (a month earlier, the probability of a 2026 hike was estimated at just 18.2%), the chance of a hike by July 2027 stands at 41%, and by the end of 2028 – 77%.

Key pressure factors

The current macroeconomic situation is shaped by a range of fundamental factors that constrain the Fed and create risks for the US economy:

1. Energy price surge as the main inflation driver. The April CPI report showed energy costs rising by 3.8% in a single month, accounting for about 40% of the overall increase in the consumer basket. Higher costs for gasoline, diesel, jet fuel, and electricity act as an indirect tax on the economy. Expensive fuel automatically increases logistics costs, airfare, factory production costs, food prices, and household utility bills.
2. Geopolitical escalation and the Iran factor. The key driver behind higher energy prices remains geopolitical friction in the Middle East and threats of supply disruptions along critical sea routes. The recent failure of peace talks and the prospect of renewed active hostilities are keeping Brent crude prices elevated. If the conflict around Iran escalates further, the energy factor will continue to push overall inflation higher.
3. Radical shift in market expectations. Investors are being forced to hastily revise their strategies. While the baseline scenario had previously been a steady decline in borrowing costs, markets are now beginning to price in an extended period of tight financial conditions and the risk of a renewed rate hike cycle. Data from the Kalshi prediction exchange clearly demonstrates that investors no longer believe in a quick return of inflation to the 2% target.
4. Trap for Fed monetary policy. The Fed's traditional mechanism involves raising rates to cool demand – for housing, autos, and business investment. However, interest rates are powerless against supply-side commodity shocks: the central bank cannot increase oil production, restore shipping safety, or resolve an international conflict. As a result, the regulator finds itself caught between two heavy risks: either maintain or raise rates and trigger an economic slowdown, or allow inflation to run out of control.

Outlook

Based on the analysis of the data presented, our forecast regarding the Fed's future actions and the state of financial markets is as follows:

In the short to medium term, investors should fully exclude from their baseline calculations any scenario of rapid and aggressive interest rate cuts. Expectations of easy monetary policy are giving way to a period of prolonged uncertainty and tight financial conditions.

The key determining factor will be the trajectory of oil prices and the evolution of the Iran conflict. If geopolitical tensions in the Middle East persist or intensify, the energy component will continue to pressure the CPI, making the 2% target unattainable. In this case, the Fed, with a probability exceeding the current 27–41%, would be compelled to move from a pause to an actual rate hike to prevent inflation expectations from becoming entrenched.

For capital markets, this signals a shift in psychological paradigm: the period of optimism fueled by hopes of cheap money is over. Equities and bonds will need to adapt to conditions in which borrowing remains expensive for significantly longer than Wall Street had anticipated, with the risk of a new tightening cycle becoming the defining factor of volatility in the years ahead.