Although the latest dot plot indicates that Federal Reserve policymakers still anticipate interest rate cuts later this year, a closer look reveals another emerging signal. Against a backdrop of inflation driven higher by tariffs and oil prices, alongside a labor market that is softening but not collapsing, some officials have hinted that their next policy move could be either a rate hike or a cut.

This represents a subtle yet significant shift. Just weeks ago, the path for interest rates was clearly pointing downward. However, over the past week, several officials have sent hawkish signals. Governor Cook, who has typically aligned with the Fed's majority view, stated that energy price increases resulting from the Iran conflict are adding further inflationary pressure, making persistent inflation the primary risk facing the Fed once again.

Chicago Fed President Goolsbee became one of the first officials to explicitly mention the possibility of raising rates. "If inflation moderates, we could still return to a path of multiple cuts this year," he told CNBC. "But I can also imagine scenarios where a rate hike would be necessary."

While a rate hike is still considered a low-probability event, the mere mention of the possibility is noteworthy. Fed Chair Powell noted this month that, in the last two meetings, officials chose not to include the option of a potential rate hike in their public communications.

Even if rates do not increase, the probability that the consecutive six-meeting rate-cutting cycle that began in September 2024 has now ended is rising.

The shift in market expectations for the Fed is a key reason long-term interest rates have surged significantly since the outbreak of the Iran conflict. Traders have revised their future rate expectations upward, even pricing in the possibility of a small rate hike this year. As these expectations are reflected in bond yields, businesses and households are already feeling the impact, such as through higher mortgage rates.

Officials sometimes push back against market pricing that contradicts their own policy expectations. However, Matthew Luzzetti, Chief U.S. Economist at Deutsche Bank, stated that, given the heightened inflation anxieties due to the Iran conflict, the Fed currently has little reason to object. He believes the market's new expectation for steady or higher future rates is beneficial for the Fed.

Importantly, many of the recent hawkish statements have come from officials previously viewed as neutral or dovish. Governor Waller, a strong proponent of rate cuts, said this month that inflation risks from the Iran conflict led him to support holding rates steady in March.

The Fed releases a dot plot each quarter, showing the year-end rate expectations of its 19 policymakers. Markets often seek clear signals from it; the median projection in the March dot plot suggested one more rate cut this year.

However, dovish San Francisco Fed President Daly indicated that this guidance could be misleading. In a LinkedIn post, she wrote that it "may convey a false sense of certainty... making it harder for the public to clearly anticipate how the FOMC will react." She noted there is no single most likely path for rates.

Chair Powell himself has downplayed the significance of the dot plot. At a press conference this month, he stated, "More than usual, it's appropriate to take forecasts with a grain of salt this time."

Reasons supporting rate cuts still exist. U.S. employment fell by over 90,000 in February, and the unemployment rate rose to 4.4%. Many economists believe that if tensions in the Middle East ease, oil prices could decline from current levels, and inflation will continue to gradually move toward the Fed's 2% target over time.

Should oil prices rise sharply, however, consumer spending and employment could be significantly impacted, potentially forcing the Fed to cut rates to avoid a recession.

Christopher Hodge, Chief U.S. Economist at Natixis, believes the Fed could still implement further rate cuts this year, stating, "The economy didn't have strong momentum heading into the year."

Nevertheless, multiple factors have collectively raised the bar for the Fed to cut rates further.

Since September 2024, the target range for the federal funds rate has been lowered by nearly 2 percentage points to 3.5%–3.75%. Further cuts would bring it closer to the neutral level, which neither restrains nor stimulates inflation.

Economists can only speculate on the precise neutral rate, but a growing number of Fed officials suggest rates may already be near that level. Fed Vice Chair Jefferson said last Thursday that recent Fed cuts have "brought the rate roughly into the neutral range." Richmond Fed President Barkin stated on Friday that after the cuts, the "federal funds rate is at the upper end of the neutral range." If rates are indeed at a neutral level, further cuts would essentially mean stimulating inflation.

Officials are also aware that, as of this month, inflation has exceeded the Fed's 2% target for six consecutive years and are concerned the public may develop entrenched expectations of persistently high inflation. Such expectations can become self-fulfilling. In this context, merely waiting for the effects of tariff shocks or oil price spikes to fade may not be sufficient to return inflation to 2%. By the Fed's preferred measure, the current inflation rate is approximately 3%.

The Iran conflict, which has driven up prices for frequently purchased items like gasoline and food, exacerbates this risk. Derek Tang, an analyst at Monetary Policy Analytics, noted that Fed officials "really don't want to see inflation expectations rise," adding, "The problem is, they don't know how close they are to the edge."

However, the Fed can take some comfort: there is currently no evidence suggesting inflation expectations have risen significantly. Last Friday, the University of Michigan's March consumer survey showed that while short-term inflation expectations edged up slightly, longer-term expectations remained subdued.