Category: Economics · Originally published on Predifi
Key Points
- US interest rates rose 35-45 basis points in March
- Markets shifted from two anticipated Fed cuts to no cuts
- European markets show larger swings due to oil exposure
- Potential long-term shift in global energy policies
- Focus on upcoming FOMC decision and oil price trends
By late Q1 2026, investors had entirely scrapped their expectations for Federal Reserve rate cuts, a stark reversal from February forecasts. The shift came as the Iran conflict, which commenced in late February, disrupted Persian Gulf oil supplies, leading to a 35-45 basis point increase in US interest rates by March. This dramatic turn of events aligns with the ongoing Fed pause cycle, bolstering no-cut forecasts and signaling a potential long-term shift in global energy policies and military spending.
The immediate impact was felt across global markets, with European markets showing particularly large swings due to their higher exposure to Persian Gulf oil. The repricing of Fed rate cut expectations is a clear signal of the interconnectedness of geopolitical events and global financial markets, highlighting the underpriced risk of long-term energy security and military budget implications.
The triggering event was the commencement of the Iran conflict in late February 2026, which disrupted Persian Gulf oil supplies. This disruption led to a spike in energy prices, causing energy-driven inflation to rise significantly. According to Argent Financial Group analysis released in April, US interest rates increased by 35-45 basis points in March as a direct result of this inflation. This rise in rates led to a complete shift in market expectations for Federal Reserve rate cuts in 2026, moving from two anticipated cuts in February to no cuts by late Q1.
The Federal Reserve, under the leadership of Chair Jerome Powell, has maintained a pause in its rate-cutting cycle, aligning with the new market expectations. European markets, particularly those with higher exposure to Persian Gulf oil, showed larger swings in response to the conflict and subsequent inflation.
The causal chain begins with the Iran conflict, which disrupted Persian Gulf oil supplies. This disruption led to a spike in oil prices, causing energy-driven inflation to rise. The increase in inflation led to higher bond yields, which in turn caused investors to reprice their expectations for Federal Reserve rate cuts. This is a classic example of the transmission mechanism seen in previous oil crises, such as the 1979 Iran Revolution, which led to an oil crisis and inflation spike that took 18 months to resolve.
The underpriced risk in this scenario is the long-term shift in global energy policies and increased military spending. As countries reassess their energy security in light of the conflict, there may be a move towards more diversified energy sources and increased investment in military capabilities, both of which could have lasting impacts on global markets.
The immediate market reaction was a repricing of Fed rate cut expectations, with investors moving from forecasting two cuts in February to no cuts by late Q1. This repricing was driven by the increase in US interest rates, which rose by 35-45 basis points in March due to energy-driven inflation. European markets, with their higher exposure to Persian Gulf oil, showed larger swings in response to the conflict and subsequent inflation.
The transmission mechanism from the Iran conflict to market repricing involved several steps: the conflict disrupted oil supplies, leading to a spike in oil prices; this spike caused energy-driven inflation to rise; the increase in inflation led to higher bond yields; and finally, the rising yields led to a repricing of Fed rate cut expectations. This chain of events highlights the interconnectedness of geopolitical events and global financial markets.
The single most important question remaining is how long the Iran conflict will last and what its long-term impact on global energy policies and military spending will be. Investors will be closely watching upcoming Federal Open Market Committee (FOMC) decisions, oil price trends, and any signs of a resolution to the conflict. The next FOMC decision, scheduled for June, will be a key data point for market expectations. Additionally, any signs of a shift in global energy policies or increased military spending will be closely monitored for their potential impact on inflation and interest rates.
Prediction markets for rate hikes, recession odds, unemployment, and earnings forecasts have all seen significant shifts. The probability of a Fed rate cut in 2026 has dropped to near zero, with a corresponding increase in the probability of higher rates lasting longer. The key upcoming catalyst will be the June FOMC decision and any signs of a resolution to the Iran conflict.
This article was originally published at predifi.com/blog/fed-rate-cut-expectations-evaporate-amid-iran-conflict-2026. Predifi is an on-chain prediction market aggregator built on Hedera. Join the waitlist →
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