Markets now price 75% chance of Fed rate hike by year-end

The Federal Reserve's next policy move is increasingly likely to be a rate hike rather than a cut, as persistent inflation and internal divisions reshape expectations for the July 28-29 meeting.

The Fed held rates at 3.50% to 3.75% in June, but minutes showed a "few" officials saw a case for hiking — a split that pushed market pricing to a 75% probability of a rate increase by year-end, according to Atlanta Fed data.

"The majority of participants highlighted the possibility that, after several years of inflation above 2%, continued elevated inflation rates could begin to affect inflation expectations and wage- and price-setting decisions," the Federal Open Market Committee's June minutes said.

Inflation stands at 4.1%, more than double the Fed's 2% target, with core inflation above 3%. Officials pointed to three overlapping pressures: tariff pass-through, energy disruptions tied to Middle East tensions, and surging electricity and hardware demand from the AI buildout — a demand-side driver that may not fade as quickly as supply shocks. The 30-year fixed mortgage rate rose to 6.61% as oil prices climbed after Iran attacked tankers in the Strait of Hormuz and the U.S. retaliated with air strikes.

The committee is effectively split on the year-end rate path: one camp expects the current range to hold or ease slightly, while another — citing AI demand, tariffs, and a still-tight labor market — sees rates finishing 2026 higher. That division means every inflation print between now and July 28-29 carries market-moving weight, with risk assets including stocks and cryptocurrencies already repricing lower.

Inflation Persistence Tests the Fed's Patience

The June meeting was the first under Chair Kevin Warsh, who shortened the Fed's policy statement and eliminated forward guidance — a move that makes the minutes' discussion of inflation the primary signal for markets. Several officials said they did not believe the current level of interest rates was putting downward pressure on inflation, according to the minutes.

Fed staff revised their inflation forecast higher for this year and next compared with the April projection, with core inflation expected to show little change over the rest of 2026. The last time the Fed faced a similar inflation persistence pattern was in 2023-2024, when rates stayed elevated for an extended period before the central bank eventually began cutting in late 2024. The fed funds rate has been unchanged since the last adjustment, and OIS markets now assign a 75% probability to a rate increase before year-end — a stark reversal from earlier expectations of a cut.

Labor Market and Geopolitical Crosscurrents

June payrolls showed declining job growth, which would normally argue against a hike. But at the June meeting — before the jobs report was released — participants described the labor market as "balanced" and expected it to remain so, with some noting "low dynamism" in hiring. Realtor.com Chief Economist Jake Krimmel said the softer jobs data was unlikely to override the Fed's "commitment to taming inflation."

The U.S.-Iran conflict, which appeared to be cooling in June, escalated again after President Trump declared the ceasefire "over" on July 8. The renewed tensions threaten to push oil prices higher and prolong supply-chain disruptions, adding another inflationary pressure that could tilt the committee toward a hike. The S&P 500 and crypto markets have already repriced lower as traders adjust for a higher-for-longer rate environment, with the next key test coming from the July consumer price index release before the Fed's July 28-29 decision.

This article is for informational purposes only and does not constitute investment advice.