Fed rate hike fears replace cut hopes as markets price December move

A dramatic repricing in US rate markets has erased expectations for Federal Reserve cuts and replaced them with a growing probability of a rate hike by December.

Just six months after markets were pricing rate cuts from the Federal Reserve, traders now see a 59% probability of a hike by December, as sticky inflation and strong jobs growth force a dramatic reversal of the policy path. The fed funds rate has been held at 4.75% to 5% since the last 25-basis-point cut in March, and this week's meeting is expected to keep it unchanged.

"Markets have undergone a complete reversal in Fed expectations," said Frank Flight, head of macro strategy at Citadel Securities. "The inflation shock from the conflict has become more entrenched across the economy, and the Fed needs to pivot accordingly."

The CME FedWatch tool shows the probability of a December rate hike at 59%, down from nearly 70% before the US-Iran peace agreement but still reflecting a dramatic swing from the rate-cut expectations that dominated early 2026. UBS Global Wealth Management has pushed back its projected timeline for cuts to March and June 2027, while Citadel Securities sees risks building toward rate increases in September, December and March 2027. Interest rate swaps price about 21 basis points of hike premium by year-end, according to Bloomberg data.

For risk assets, the implications are significant. Higher interest rates increase borrowing costs, reduce liquidity and compress valuation multiples, threatening a broad sell-off across stock indices and rate-sensitive sectors such as technology and real estate. Bond yields have already begun to spike, and the US dollar is strengthening as the repricing takes hold across global markets.

What Changed

The reversal stems from two forces: persistent inflation and a reaccelerating labor market. Core inflation remains above 3%, according to Citadel Securities, while wage growth is accelerating fastest in cyclical industries. A growing share of consumer price components are rising at an annualized pace above 3%, the firm noted. On the jobs front, nonfarm payrolls have continued to surprise to the upside, eroding the case for any further easing.

The US-Iran peace agreement, which eased energy supply concerns and lowered oil prices, initially reduced expectations for aggressive rate action. But the underlying inflation dynamics have proven stickier than anticipated. "Easy financial conditions, lingering supply chain disruptions, a reaccelerating labor market and a surge in artificial intelligence investment" are forces that could keep price pressures elevated, Flight said.

The Warsh Era Begins

This week's Federal Reserve policy meeting marks the first under Chairman Kevin Warsh, who took over amid expectations of a more dovish approach. Instead, analysts expect a hawkish tone both in the statement and in the dot plot — the individual rate projections from 19 Fed officials. UBS analysts predict at least five officials will pencil in rate increases, with core inflation forecasts above 3% for 2026 and a slightly lower unemployment rate.

Under a Taylor Rule framework, the current mix of inflation and employment data would point to roughly 75 basis points of policy tightening this year, according to Citadel Securities. A shift toward a tightening bias as soon as July could set the stage for a September rate hike, the firm said.

The last time markets underwent a comparable repricing from cuts to hikes was in 2022, when the Fed embarked on its most aggressive tightening cycle in decades. The S&P 500 fell 19% that year as the fed funds rate rose from near zero to above 4%. If the current trajectory holds, the impact on equities and rate-sensitive sectors could be similarly severe, with the added complication of elevated valuations in technology and AI-related stocks.

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