Traders see 60% odds of Fed rate hike by October as equities slide

Traders fully priced in a Federal Reserve rate increase by the October meeting Tuesday, pushing the S&P 500 down 1 percent and sending the Dow Jones Industrial Average 349 points lower as the central bank's two-day policy meeting got underway.

"The market is repricing for a more aggressive Fed than anyone expected three months ago," said Brandon Zureick, chief economist and senior managing director at Johnson Investment Counsel. "The combination of sticky inflation, a strong labor market, and an energy shock has flipped the rate-cut narrative entirely."

The S&P 500 fell 1 percent, the Dow dropped 0.7 percent to 51,671, and the Nasdaq Composite declined more than 0.8 percent. CME FedWatch data showed futures traders pricing a 60 percent probability of a quarter-point hike by the Federal Open Market Committee's Oct. 27-28 meeting, up from roughly 48 percent before the May jobs report. The 2-year Treasury yield edged up to 4.066 percent, while the 10-year yield held near 4.47 percent.

The repricing marks a dramatic reversal from the start of 2026, when markets anticipated at least two quarter-point cuts by December. Now, with the May consumer price index showing annual inflation at 4.2 percent — the fastest pace in three years — and nonfarm payrolls adding 172,000 jobs in May, the Fed's next move may be higher. The June meeting, the first under new Chair Kevin Warsh, concludes Wednesday with a rate decision and press conference at 2:30 p.m.

Inflation and Labor Data Reshape the Rate Path

The May CPI report, released June 10, showed headline inflation rising 0.5 percent month over month and 4.2 percent from a year earlier, the highest annual pace since April 2023. Energy prices accounted for more than 60 percent of the monthly increase, the Bureau of Labor Statistics said. Core CPI, which excludes food and energy, rose 0.2 percent month over month, slower than April's 0.4 percent gain, but the annual rate ticked up to 2.9 percent.

The May jobs report added to the hawkish case. The U.S. economy added 172,000 jobs, nearly double the 88,000 economists had forecast, while the unemployment rate held at 4.3 percent. Revisions to March and April pushed those months higher, bringing the three-month average to more than 188,000.

Warsh's First Test

Kevin Warsh, confirmed as Fed chair on May 13, presides over his first FOMC meeting this week. The former Fed governor, who served from 2006 to 2011, is widely viewed as a hawk on monetary policy, though he has more recently advocated for lower rates. The committee is expected to leave the federal funds rate unchanged.

The focus will be on the Summary of Economic Projections and the dot plot, which in March showed a median forecast of two additional rate cuts in 2026. That path may no longer reflect the committee's current thinking. Warsh has been skeptical of forward guidance and may signal a shift in how the Fed communicates policy.

The Iran peace deal, announced Sunday, sent crude oil prices tumbling — West Texas Intermediate fell 4.9 percent to $80.75 a barrel — and may ease some inflationary pressure. But the agreement's details remain uncertain, and oil prices had surged from $67.02 on Feb. 27 to an intraday peak of $119.48 on March 9 after the Strait of Hormuz was effectively closed.

For investors, the repricing of rate expectations has broad implications. Higher rates can pressure equity valuations, increase borrowing costs, and strengthen the dollar. The next key data point is the June CPI report, due July 15, which will show whether the Iran peace deal and falling oil prices are beginning to feed through to consumer prices. If inflation moderates, the case for a hike weakens. If it remains sticky, the October meeting becomes a live event.

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