Oil prices surge hitting inflation's bottom line: The Federal Reserve's "no rate cuts" stance this year is shifting from an extreme assumption to a market mainstream

Financial Express APP learned that due to the ongoing escalation of conflicts in the Middle East pushing up oil prices and potentially further fueling inflation expectations, bond options traders are increasingly betting that the Federal Reserve will abandon its rate cut plans this year.

According to the latest data compiled by the Atlanta Fed, as of this Wednesday, traders believe there is a 25% chance that the Federal Reserve will keep the benchmark interest rate within its current range before December. This is a significant increase from 17% last Friday (the last trading day before the Iran conflict erupted), reflecting rapid market adjustments in expectations of a shift in Fed monetary policy.

Among various policy scenarios, maintaining the current interest rate has become the most likely single outcome. Data from the Atlanta Fed shows that the probability of a single rate cut (25 basis points) is 24%, while the chance of two cuts is 12%. Traders even see a 16% chance of a rate hike, sharply up from 8% last Friday. All these figures are based on SOFR futures options tied to the Fed’s policy rate.

“When oil prices surge, we must prioritize their pass-through effects on inflation,” said Dan Carter, senior portfolio manager at Ford Washington Investment Advisory. “This directly raises inflation expectations and significantly reduces the likelihood of the Fed cutting rates.”

Although, when considering all possible scenarios, the overall probability distribution still leans toward rate cuts, the sharp shift in pricing reveals a dramatic shake-up in market confidence—since oil prices have already surged nearly 20% this week, traders’ confidence in the Fed’s ability to lower borrowing costs has been greatly diminished. Recent days’ options trading flows clearly indicate ongoing demand to hedge against the risk of weakening Fed easing.

As another key tool for betting on Fed policy, the interest rate swap market also reflects market expectations that the central bank’s stance will become less dovish. Traders currently expect about a 35 basis point rate cut by the end of the year, down from last weekend’s expectation of as much as 60 basis points.

This sharp cooling of rate cut expectations has directly triggered a recent sell-off in US Treasuries, pushing yields to multi-week highs and marking a complete reversal of the strong rally seen in February. At that time, concerns about AI’s disruptive potential, combined with signs of cracks in the private credit market, fueled a surge in safe-haven demand. Now, with inflation risks resurfacing due to rising oil prices, market logic has undergone a fundamental shift.