The Federal Reserve is signaling patience on interest rates, but markets and macro data are quietly rebuilding the case for another hike this year. For owners, lenders and developers who had begun to plan around a shallow easing cycle, the discussion is shifting from how many cuts to whether the tightening campaign is actually over.
At its March meeting, the Fed kept the federal funds rate in a range of 3.5% to 3.75% and reiterated its 2% inflation goal, while officials' projections continued to show a single quarter‑point cut this year and another in 2027.
Chair Jerome Powell stressed that those forecasts depend on inflation resuming its decline, a caveat that now looms larger as recent data show price pressures stuck above target. The central bank's preferred gauge, the personal‑consumption expenditures price index, was running at 2.8% in January, with core PCE at 3.1%, only modestly below late‑2024 levels. A narrower measure that Fed officials have used to strip out volatile components—core services excluding housing—has also hovered around 3.5% for roughly a year, well above its pre‑pandemic pace.
Stubborn inflation tests Fed assumptions
That persistence is testing the Fed's operating assumption that anchored inflation expectations and a cooling labor market would gradually pull inflation back to 2% without the need for much tighter policy. Since mid‑2024, policymakers have treated pandemic‑era inflation as largely transitory, driven by supply shocks such as tariffs and lagged housing data and argued that expectations would do much of the work once those distortions faded.
Instead, overall inflation and the services‑ex‑housing gauge have barely moved, prompting Powell to describe the progress as "frustrating" in an exchange with Wall Street Journal reporter Nick Timiraos.
BNP Paribas chief U.S. economist James Egelhof argues that if expectations are not delivering lower inflation, the Fed may have to fall back on the traditional tool of slower growth and softer employment, which in practice means maintaining or even raising rates rather than cutting them.
Energy markets and fiscal policy are complicating that calculus. The war with Iran and the closure of the Strait of Hormuz have driven Brent Crude Oil more than 50% higher since the conflict began, with prices recently surpassing 116 dollars a barrel.
Historically, the Fed has often looked through temporary oil spikes, on the view that higher gasoline prices squeeze household spending and damp second‑round effects on wages and other prices.
In severe shocks, that logic can even argue for rate cuts to cushion the blow. This time, however, several offsets limit the hit to demand. Adjusted for inflation, even 4‑dollar gasoline would be well below 2008's peak. U.S. gasoline consumption is lower relative to output, and the country is now a net petroleum exporter and major LNG supplier, which means higher prices bring some macro benefit.
Those cushions are being reinforced by policy choices in Washington. The Trump administration has moved aggressively to "run the economy hot" ahead of November's midterm elections, with a Republican tax package expected to inject about $200 billion through cuts and refunds. The Pentagon is preparing to seek an additional $200 billion for operations against Iran and regulators are preparing to ease capital requirements for large banks, potentially encouraging more lending and deal activity.
Taken together, those steps help explain why Fed officials and most private forecasters have not significantly cut their growth or unemployment projections since the war began. The flip side is that there is little demand‑side buffer against an inflation shock from energy or tariffs.
Markets reprice the odds of a hike
Financial markets have responded quickly to the changing mix of risks. In fed funds futures, the probability of a rate cut this year has dropped from roughly 72% at the end of 2025 to about 37%, while the implied odds of a hike have climbed to 45%, according to estimates from the Federal Reserve Bank of Atlanta.
The shift has driven a sell‑off in shorter‑term Treasuries: the two‑year yield, which tends to track policy expectations, has risen by about half a percentage point since the start of the Iran conflict, touching 3.94% before easing back slightly. Investors are now assigning roughly even odds to a quarter‑point increase by October, a stark reversal from prewar pricing that assumed two or three cuts by year‑end.
Strategists caution, however, that market prices reflect more than simple forecasts of Fed decisions. Subadra Rajappa, head of U.S. rates research at Société Générale, told The Financial Times that investors are re‑evaluating assumptions about U.S. energy independence and how quickly oil‑related shocks fade, amid signs the conflict and supply disruption could prove more protracted than in past episodes.
RBC Capital Markets' Blake Gwinn told the publication that futures pricing has become "a bit hawkish" and argues that it has "detached from the fundamentals," meaning traders may be paying for insurance against a hawkish outcome rather than betting that the Fed will definitely raise rates this year.
Policy no longer deeply restrictive
One reason officials have not embraced a hike as their base case is that policy is no longer as restrictive as it was at the peak of the tightening cycle. After holding the funds rate between 5.25% and 5.5% in 2024, the Fed began cutting in September as unemployment rose and inflation eased, then paused when new tariffs threatened to push prices higher before resuming cuts as the labor market again softened.
With the target now just above officials' revised 3.1% estimate of "neutral," monetary policy is only modestly leaning against growth. Real rates are even lower than the nominal stance implies. Because what matters for spending and investment is the inflation‑adjusted cost of money, leaving rates unchanged while inflation drifts higher reduces real yields and effectively eases policy.
Former senior Fed staffer William English points out that the real two‑year Treasury yield has fallen this year even as the nominal yield has ticked up, and warns that if the current inflation surge proves durable, that erosion in real policy tightness could become "a real issue."
There are several forces that still favor patience. Fed officials expect some of the tariff and housing‑related price pressure to fade, allowing inflation to resume its decline without additional restraint.
Wage growth has slowed to under 4% annually, a pace that—combined with better productivity—appears compatible with returning inflation to 2% over time.
And as the conflict with Iran stretches on, the chance increases that energy prices will rise enough, for long enough, to significantly damage growth and destabilize financial markets, potentially tipping the economy toward recession and, eventually, disinflation. For now, that leaves both policymakers and investors operating in a genuinely two‑way environment, where the next significant move in rates could be up or down—and where commercial real estate executives must plan for either outcome without assuming a smooth glide path to lower borrowing costs.
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