The market is beginning to price in a 50% probability of a rate hike in October, with rate cut expectations completely wiped out, moving closer to at least one hike within the year.

The main logic behind market pricing:

1. It doesn't look like the next FOMC will hike immediately; rather, the probability of at least one hike by October or within the year has risen significantly. Today's media-cited market implied probabilities are roughly in the 40% to 60% range, with differences mainly stemming from different timeframes and methodologies.

2. After Middle East conflicts have impacted oil and gas infrastructure these past few days, crude oil surged to around 119 dollars per barrel and remains volatile at high levels above 100 dollars. The market's concern is that imported inflation could resurface, with gasoline, transportation, chemical, and shipping costs cascading downstream.

3. This round of inflation never fully came down to begin with, so crude oil shocks are particularly prone to altering the trajectory.

US February CPI year-over-year at 2.4%, January PCE year-over-year at 2.8%, core PCE year-over-year at 3.1%, February PPI month-over-month at 0.7% and year-over-year at 3.4%. In other words, even before the oil price spike, inflation data was already quite fragile, and the market's previous smooth rate-cut narrative is being disproven.

4. The economy hasn't weakened enough to force the Fed to intervene.

The Fed's March 18 statement indicated that the economy is still expanding steadily, unemployment changes are modest, inflation remains elevated, and there is uncertainty regarding Middle East developments' impact on the US economy. In the same period, the SEP raised the 2026 GDP median projection from 2.3% to 2.4%, maintained unemployment at 4.4%, but raised both 2026 PCE and core PCE to 2.7%; the federal funds rate median remains at 3.4%, corresponding to a baseline scenario looking more like just one rate cut, not rapid easing. February nonfarm payrolls fell by 92,000 and unemployment at 4.4% also indicate the economy hasn't deteriorated enough to immediately force the Fed to turn dovish.

So the main line of market pricing is actually quite clear:

First eliminate rate cut expectations, then lock in higher rates persisting longer, finally add a tail probability of hikes within the year. Essentially, trading rising stagflation risk, not trading renewed economic overheating.

The increase in hike probabilities we see now contains a significant portion that represents insurance and hedging against an out-of-control oil price scenario. If energy shocks moderate, that portion of hike pricing will fall quickly as well.