Inflation Tops Forecasts as Energy Prices Surge Post-Iran Conflict, Lifting Odds of Fed Rate Hike

Markets on May 12, 2026, raised the probability of a Federal Reserve rate increase before the end of the year to about 37% after a hotter-than-expected inflation report, according to CME Group's FedWatch tracker. The same pricing took virtually any chance of a Federal Reserve rate cut off the table between May 2026 and the end of 2027, the tracker of 30-day fed funds futures contracts showed.

A customer shops for produce in an H-E-B grocery store on May 11, 2026 in Austin, Texas, as the Bureau of Labor Statistics released its consumer price index data that day or the next.

Since the Iran war began in late February 2026, energy prices have been soaring and accounted for more than 40% of the gain in the consumer price index. The headline inflation level reached its highest in nearly three years. Derivative contracts known as forwards have been climbing higher since the Iran war began in late February 2026 and were hovering around levels last seen in the autumn of 2025.

While consumer surveys have indicated elevated inflation expectations, market-based measures had been mostly benign until the recent shift. "At this point, I suspect they just stay on hold," Mark Zandi, chief economist at Moody's Analytics, told CNBC.

He added that the deciding factor for the Fed will be inflation expectations and if they break out any further the Fed will likely start raising interest rates.

The hawkish shift poses a particular challenge for incoming Fed Chair Kevin Warsh, who is expected to take the reins later in May 2026. Kevin Warsh has been outspoken in favor of cutting interest rates. "I just don't see how he's going to get any kind of support for cutting interest rates in the current environment," Mark Zandi said of Warsh.

To be sure, some Wall Street commentary stressed the importance of the energy shock on the CPI data. The April CPI increase was much smaller when stripping out food, energy and shelter, according to Raymond James. 6% in April, its biggest monthly increase since September 2023.

Eugenio Aleman, chief economist at Raymond James, pointed to that underlying detail. Similarly, Jefferies economist Thomas Simons noted that there is still only slight evidence that the energy inflation spike is spreading through the economy. Thomas Simons expects the Fed to stay on hold as it watches events unfold.

"As time goes by, the chances of a rate cuts at any point this year are fading, but we still expect that the next move in policy rates is going to be a cut rather than a hike," Simons said in a note. com reported that traders moved further away Tuesday from expecting any Federal Reserve interest rate cuts and in fact began anticipating a higher probability that the next move would be a hike.

President Donald Trump has been equally vocal about his expectations for an easing central bank, adding another layer of tension for the incoming chair as inflation expectations drift higher.