Three months ago, futures markets were pricing a 95% probability of at least two Federal Reserve rate cuts in 2026. As of March 24, that probability has collapsed to approximately 5%, with futures now assigning a 40% chance of at least one rate hike before year-end. The trigger is not a stronger-than-expected economy. It is a war, an oil price surge, and the inflationary spiral that energy shocks historically inject into every corner of the goods-producing economy.
By the Numbers: What Has Changed Since February
The speed of this repricing is historically unusual. In the six weeks since the US-Iran conflict escalated, the macro policy environment in the United States has shifted more dramatically than at any comparable geopolitical trigger point in recent decades. The following data points define the scale of the shift.
Oil prices have risen approximately 70% from their pre-conflict levels, with Brent touching $104 per barrel on March 24 versus approximately $62 in early February.
The 10-year US Treasury yield spiked to 4.4% last Friday — the highest since last July — in a move that contradicted every historical pattern of flight-to-safety buying that normally accompanies geopolitical volatility. Treasury bonds did not rally. They sold off.
The CME FedWatch Tool shows the probability of a rate cut at the next FOMC meeting has dropped from a near-certainty to single digits within 30 trading days — one of the fastest probability collapses on record for a meeting that was previously considered a foregone conclusion.
The Russell 2000 index of small-cap companies dropped more than 2.5% last Friday alone, its worst single-day performance among major indices, as elevated yields weighed most heavily on the smaller companies most dependent on floating-rate debt financing.
Average US gasoline prices reached $3.54 per gallon — a 21% increase in under a month — hitting consumers before any of the secondary inflationary transmission through supply chains has even begun.
Why the Treasury Market's Behaviour Is the Most Important Signal
The bond market is telling a story that equity markets have been slow to absorb. When geopolitical crises hit — historically — money flows into US Treasuries as the world's pre-eminent safe asset, driving yields down. That is not happening this time. Yields are rising despite the crisis, which means the bond market is weighing two competing forces and concluding that the inflation risk from sustained high oil prices outweighs the flight-to-safety demand for US government debt.
This is the signal that puts the Fed in its genuinely difficult position. The central bank's mandate is price stability and maximum employment. An oil price shock that pushes headline CPI back toward 4–5% is a direct threat to price stability — but the appropriate monetary policy response to a supply-side inflation shock is deeply contested. Raising rates does not produce more oil. It does not reopen the Strait of Hormuz. What it does is slow demand by tightening financial conditions — which means accepting lower growth and higher unemployment as the price of fighting energy-driven inflation. Mark Zandi of Moody's Analytics captured it plainly: "Higher oil prices are another negative supply shock, lifting inflation and hurting growth — putting the Fed in a no-win situation."
The Historical Precedent That Should Concern Everyone
The 1973 and 1979 oil shocks remain the textbook reference points for energy-driven stagflation, but the more relevant comparison may be 2022, when the Federal Reserve misread the transitory nature of post-pandemic inflation and fell behind the curve by approximately 18 months. The consequence was the most aggressive rate hiking cycle in 40 years. Fed officials have since acknowledged that the delayed response compounded the inflation problem significantly.
The risk of a 2022 repeat is structurally present in 2026. If the Fed "looks through" the energy price spike — treating it as temporary and transitory — and the Strait of Hormuz disruption extends into Q2 2026, headline inflation will embed at elevated levels before the central bank begins to respond. The Fed's own post-2022 institutional learning argues for a more proactive stance this time. But a proactive stance means rate hikes into a slowing economy, which is politically and economically uncomfortable in an election-adjacent environment.
What This Means for Different Asset Classes
For equity investors, the repricing of rate cut expectations is a negative for valuation multiples, particularly in long-duration growth stocks whose discounted cash flow valuations are most sensitive to the risk-free rate. The software sector's 20% decline so far in Q1 2026 — what market commentators dubbed the "Di-SaaS-ter" earlier this year — is the clearest expression of this repricing in action, though energy infrastructure stocks, industrials exposed to data center construction, and commodity-linked equities remain structurally insulated.
For fixed income investors, the current Treasury yield environment — with the 10-year at 4.4% and rising — creates an unusual opportunity if diplomatic resolution materialises. A Strait reopening and oil price normalisation would trigger a rapid reversal of the inflation risk premium embedded in current yields, potentially driving yields back toward 3.8–4.0% and generating meaningful capital gains for holders of long-duration Treasuries purchased at current levels.
For corporate treasury managers and CFOs, the near-term implication is straightforward: the window for refinancing floating-rate debt at low fixed rates that appeared open in January 2026 has effectively closed. Companies that did not refinance before the conflict should now be stress-testing their debt service obligations against a scenario in which the policy rate rises once or twice in 2026.
The Leading Indicators That Will Tell Us Which Way This Resolves
Three data releases in the next two weeks will be decisive for the rate outlook. The March PMI data from S&P Global, released today, will provide the first quantitative signal of how quickly the energy shock is transmitting into industrial output and business confidence across major economies. This week's Treasury auction results — particularly the 2-year note sale — will indicate whether international demand for US government debt is holding despite the yield spike, or whether the "no safe haven" dynamic is deepening. Finally, the April FOMC meeting preview communications from Fed Chair Jerome Powell, expected in the first week of April, will signal whether the Fed is already shifting its reaction function in response to the energy shock or maintaining its prior easing orientation.
The outcome that financial markets appear to be betting on — oil prices normalising and the Fed resuming its easing path in H2 2026 — requires diplomatic resolution faster than current ground-level signals suggest is likely. The outcome the bond market appears to be pricing — persistent energy inflation, delayed easing, and possible hiking — requires the Strait disruption to extend beyond April. The spread between those two scenarios is where the most consequential investment decisions of the next quarter will be made.
Outlook: The Fed's Credibility Is Now the Second-Order Risk
Beyond the immediate rate path question, the Middle East conflict has created a credibility risk for the Federal Reserve that markets have not yet fully priced. If energy-driven inflation re-accelerates and the Fed responds too slowly — as it did in 2021–2022 — the institutional trust that anchors inflation expectations will erode again, potentially requiring an even more aggressive eventual tightening cycle than a prompt response would necessitate. What will determine whether the market ends 2026 at the top or bottom of its projected range is not the oil price itself — it is whether the Fed's credibility is strong enough to keep long-run inflation expectations anchored while the supply shock works its way through the system.