Accelerating Inflation May Prompt Higher Interest Rates This Year
Kevin Warsh answers questions during his nomination hearing in April 2026 (AP foto/Jose Luis Magana)
Associated Press
Prior to the Iran war annual inflation was decelerating and relatively close to the Fed’s 2% policy target and there was an expectation interest rates could fall. However, with the Strait of Hormuz still effectively closed and limiting energy shipments, so energy prices have risen. Reflecting that, April saw Consumer Price Inflation at a 3.8% annual rate, that’s an abrupt spike from 2.4% in February. Of course, if food and energy costs are excluded, then the rise is less acute, but inflation has still accelerated to 2.8% and may rise further, that’s largely because energy prices are a input for many other goods and services across the economy. Those ripple effects are just starting to play out.
Typically, when inflation rises, all else equal, the Federal Open Market Committee is more likely to raise interest rates in response. That’s because higher rates are the key tool that the FOMC has to tame inflation.
That said, prior to the Iran conflict, the FOMC were looking to cut interest rates rather than raise them. In addition, energy prices can be volatile and if the Strait of Hormuz to reopened tomorrow, that could lead to lower energy costs in short order, perhaps reversing the spike we’ve seen in prior months. Still, shipping traffic remains blocked, and markets are now starting to contemplate interest rate increases.
Expectations for Higher Rates
Fixed income markets are now expecting the FOMC to perhaps raise interest rates in 2026. That’s a recent development. A month ago, expectations were for interest rates to remain broadly flat. Now, the expectation is that interest rates could be raised from their current level of 3.5% to 3.75% to 3.75% to 4% by the end of the calendar year, and perhaps higher still.
In terms of timing, markets don’t expect the FOMC to act immediately. The consensus for the first scheduled meeting that Kevin Warsh will chair in June is for rates to be held steady. However, beyond that, expectations of a rate increase rise at subsequent meetings. A hike is more likely than not at the FOMC’s final scheduled meeting of the year in December and may come sooner, that’s according to the CME’s FedWatch Tool.
MORE FOR YOU
Currently there are no longer any meaningful expectations for rate cuts. The question is whether the FOMC holds rates constant or increases them a little according to fixed income markets. It may be that even if the Strait of Hormuz were to reopen tomorrow, the FOMC would still have to manage to the inflation that resulted from its effective closure for many weeks.
A Robust Jobs Market
The FOMC is also accountable for maintaining full employment with monetary policy. Although jobs data has been volatile, the most recent jobs reports from the Buearu of Labor Statistics have shown relatively robust nonfarm payroll growth in both March and April. That gives the FOMC a little more flexibility in potentially raising rates since, for now, there is limited evidence that the FOMC needs to lower rates to support the jobs market.
What To Expect
For much of 2026, the debate was how soon and how much the FOMC might ultimately cut rates in 2026. Now that narrative is flipped and the question for fixed income markets is whether the FOMC will hold rates steady or chose to raise them. To the extent that the current wave of inflation persists ro accelerates, the FOMC may have to raise rates sooner. Warsh’s initial meetings as Fed Chair, may prove more complex than previously anticipated.