Markets now see the Fed's next move as a potential rate hike as inflation fears mount

Surging energy prices, rising import costs and mounting stagflation concerns are pushing markets to consider that the Federal Reserve's next move could be a rate hike.

Traders in the futures market pushed the probability of a rate increase by the end of 2026 to 52% on Friday morning, the first time it has crossed the 50% threshold, according to the CME Group FedWatch tool.

The move comes as global benchmark crude prices topped $110, adding to a series of developments this week signaling that inflation pressures may be building as the Iran war drags on and U.S. tariffs raise costs.

Adding to the inflation concerns, the Bureau of Labor Statistics reported Wednesday that import prices jumped 1.3% in February, the largest monthly increase since March 2022, while export prices rose 1.5%, the biggest gain since May 2022.

At the same time, the Organization for Economic Cooperation and Development sharply raised its forecast for U.S. inflation this year. The global forecasting agency estimates headline prices to rise at a 4.2% rate, far above its prior forecast and well above Fed expectations for 2.7%.

The concerns about inflation come at the same time as Wall Street economists have boosted probabilities for a recession in the next 12 months.

Moody's Analytics sees the chances for a downturn near 50%, Goldman Sachs raised its forecast this week to 30%, and firms such as EY Parthenon and Wilmington Trust are putting odds at 40% or greater.

The chances for both elevated inflation and an economic pullback place the Fed's dual goals of low inflation and full employment further into tension. Central bank officials at their March meeting indicated a consensus view of one rate cut this year, but market pricing, while far from a lock for an increase, points to no chance of a reduction.

However, in a speech Thursday, Federal Open Market Committee Vice Chair Philip Jefferson indicated that the recent developments are not necessarily an impetus to raise rates.

Instead he noted that uncertainty over tariffs and the jump in oil prices "complicates, at least in the short term, the picture on both sides of our dual mandate of maximum employment and price stability" meaning "downside risk to the labor market and upside risk to inflation."

"While that is a potentially challenging situation, I am confident that our current policy stance is well positioned to respond to a range of outcomes," Jefferson added.

The FOMC next meets April 28-29. Market implied odds are overwhelmingly for the Fed to stay on hold, with just a 6.2% probability of a hike.