A hotter-than-expected wholesale inflation reading for February has significantly altered market expectations regarding the Federal Reserve's interest rate policy, with traders now contemplating the possibility that the Fed may not lower rates at all in 2026 [1]. The Bureau of Labor Statistics reported that the producer price index (PPI) posted its largest gain in a year, prompting futures markets to push any realistic chance of a rate cut back to at least December. Even then, the odds of a reduction at the final Fed meeting of the year have fallen to about 60%, reflecting persistently higher inflation driven by tariffs, the Iran war (which began on Feb. 28), and elevated services costs [1].
Prior to the onset of the Iran war, traders had anticipated rate cuts in both June and September, with a possible additional cut in December. However, the probability of a June cut has dropped to 18.4%, July to 31.5%, and September to 43.6%, according to the CME's FedWatch tool, which calculates probabilities using 30-day fed funds futures contracts [1]. The chances for a December reduction stand at 60.5%, indicating a leaning toward a cut but with relatively low conviction. Futures are now implying a 3.43% fed funds rate by the end of 2026, compared to the current level of 3.64% [1].
Eugenio Aleman, chief economist at Raymond James, stated that the wholesale inflation reading "likely reinforces a hold decision by the Federal Reserve later today but tilts the risk toward a more hawkish tone in today's FOMC" statement. Aleman added that even if rates are left unchanged and there are multiple dissents, the messaging may lean toward 'higher for longer,' especially with energy inflation expected to re-enter the picture in coming months [1].
While trading in fed funds futures remains volatile and the Fed could be pushed into an easing stance if the labor market weakens further, Fed Governors Stephen Miran and Christopher Waller have advocated for immediate cuts. However, the rest of the committee appears more inclined to maintain current rates until the economic outlook becomes clearer [1].
CONCLUSION
The hotter-than-expected inflation report has led markets to delay expectations for Fed rate cuts, with the earliest likely cut now seen in December and even that with moderate conviction. Persistently high inflation, driven by tariffs and the Iran war, has prompted a more hawkish outlook from the Fed, increasing uncertainty and volatility in rate expectations. Market participants will be closely watching upcoming economic data and Fed communications for further guidance.