MW What would cause the Fed to hike rates this year? The answer might surprise you.

By Greg Robb

Later this month, the Kevin Warsh-led central bank will start preparing a possible pivot to tighter policy

President Trump has stridently pushed for lower interest rates. Here, he speaks to Kevin Warsh after he was sworn in as the new Federal Reserve chair last week.

Inflation has been persistent for the past several months, and there's little sign it's letting up anytime soon. Nonetheless, Federal Reserve officials have been hesitant to raise interest rates, even as recent data suggest inflation may easily cross the 4% threshold - double the central bank's 2% target.

The new chair of the Fed, Kevin Warsh, has argued there is still a path to lower rates. So what scenario would force the Fed to pivot sharply and raise rates?

It's not a further steep increase in oil prices (CL00) (BRN00). Instead, the scenario with the greatest risk of rate hikes this year is if the Iran war continues on its current path of stalemate and uncertainty, leaving oil prices elevated but unprecedentedly high, said Matthew Luzzetti, chief U.S. economist at Deutsche Bank.

In that scenario, "energy prices haven't risen enough to derail a resilient economy, but they have risen enough to reinforce inflation dynamics," Luzzetti said. Elevated oil prices could spill over into core inflation and consumers would come to accept higher prices, giving companies room to raise prices further, which could set off a spiral - the worst outcome for the Fed.

So far, Fed officials have shied away from calling for interest-rate hikes. In recent speeches, they have promised to hold rates steady for an extended period, hoping a resolution to the Iran war might bring inflation down.

"Americans want lower prices at the pump and lower food prices, but they also recognize that it depends on the war in Iran," said San Francisco Fed President Mary Daly, in an interview with Fox Business on Friday.

Raising rates would be a dramatic shift for the Fed. Ever since the fall of 2024, the Fed has been slowly but steadily cutting rates. Last fall, the Fed cut them by 75 basis points to a range of 3.50% to 3.75%.

At the start of this year, rate hikes were not on anyone's radar. In their last forecast of the path of interest rates, none of the 19 top Fed officials penciled in a rate hike, and their most recent statement continued to use language signaling officials saw more rate cuts ahead.

What is worrying is that the scenario with the greatest risk of rate hikes is also the most likely outcome, according to some experts.

Despite all the talk in the past week of some tentative peace agreement between the U.S. and Iran, a muddled status quo similar to current conditions is likely to remain for months, said Tina Fordham, chief geostrategist at London-based Fordham Global Foresight.

By the end of the summer, the conflict with Iran will be "probably in a very similar place to where we are now," Fordham said, in an interview with Bloomberg. That's in part because Iran is more influential than it was before the war and can threaten to choke oil supplies through the Strait of Hormuz.

The strait is the most critical energy transit chokepoint in the world, with about 20% of the global oil flows passing through the narrow waterway that borders Iran.

Even if the strait were to reopen tomorrow, it would only delay - not eliminate - the chances of a rate hike, Luzzetti said. The recent energy shock isn't the most important driver of inflation dynamics, he noted; core inflation, which excludes energy and food prices, was rising before the war, and there are reasons to think it persists.

"Even if we get a near-term resolution [to the conflict], there will still be the potential for the Fed to raise rates, either this year or into 2027," Luzzetti said.

What scenario might cause the Fed to cut rates? An intensification of the conflict with Iran, according to Luzzetti.

"The Fed would be worried about downside growth risk if we were to see a run-up in oil prices that was sustained," he said. At the same time, there is also the possibility of another substantial inflation shock that would compel rate hikes.

Inflation outlook is a test for Warsh

The real possibility the Fed will need to raise rates presents the central bank with a challenge. Experts often describe the Fed as an oil tanker that needs immense lead time before any change of direction.

"The switch from cutting to hiking is a big decision for the Fed, as it starts them and the market on a new pricing path, and the FOMC wants to be extra certain it's the right path to be on," said Steven Blitz, chief U.S. economist at TS Lombard, a private bank based in London.

Read: U.S. inflation rate hits three-year high - and it might get worse

Navigating the possibility of a rate hike will also be a challenge for Warsh, who is completing his first week at the helm of the central bank. Warsh came into office insisting there is a path for the Fed to continue to lower rates.

"I think this is a test for the new chair," said former St. Louis Fed President James Bullard, in an interview with MarketWatch. "Markets always test the new chair. They're trying to find out how will this person react in different situations."

Warsh's first interest-rate committee meeting will be in a little more than two weeks on June 16-17.

In anticipation of that meeting, bond traders have pushed up the yield on the 2-year Treasury note BX:TMUBMUSD02Y, signaling a much higher path for rates than two months ago.

A separate measure, the Atlanta Fed Market Probability Tracker, also shows that markets think the next time the Fed makes a move on interest rates will be a rate hike.

At the June meeting, Fed watchers widely expect the central bank to hold rates steady. But markets will want to see if Warsh is willing to even hint at the possibility of a rate hike, Bullard said. There is nagging concern that Warsh cannot act independently of White House officials including President Donald Trump, who are insisting rates can be cut further.

"At this moment, markets think the Fed should hint in a hawkish direction. If Warsh is unwilling to do that, it would be a bad sign from a market point of view and probably set inflation higher," Bullard said.

Read: The bond market has a warning for the Fed

One subtle hint the Fed could send would be to signal the next move could either be a rate hike or a cut. From speeches by Fed officials over the past few weeks, it looks like this shift in language has wide support.

"I actually think it wouldn't hurt Warsh to go along and say, 'We may have to raise and we're not doing it today, but maybe later this year if things don't come under control,'" Bullard said. That type of hint from the Fed chair is the most likely outcome of the meeting, he added.

Despite hesitancy from Fed officials, economists see a path to rate hikes

Several economists say that rate hikes are definitely on the table given the inflation outlook.

Juhi Dhawan, macro strategist at Wellington Management, said there was a 100% chance of a rate hike this year.

If the economy doesn't slow from the higher gas prices and if inflation doesn't cool due to relief from tariffs, "I think you will set yourself up for a more hawkish Fed," Dhawan said, in an interview with MarketWatch.

By September, Fed officials should be able to discern whether a hike is needed.

"The business cycle would be well served if you move early and have to move less, than move later and have to move more," she said.

Dhawan noted that last year's cuts were on an "insurance basis" to guard against a weak labor market, and rate hikes this year would be the same except guarding against the risk of higher inflation.

Steve Englander, head of North America strategy for Standard Chartered Bank, sees core inflation on a mild upward trend, but was not concerned about the most severe case, he said in an interview.

"If it was [former Fed chairs Ben] Bernanke or [Janet] Yellen, we'd probably have a couple of hikes priced in over the next two years," he said. But Warsh can put off any tightening, Englander noted.

"Warsh has enough control of the agenda and the discussion that he can delay a hike for long enough," Englander said - adding that if inflation pressures were more severe, he wouldn't be able to.

-Greg Robb

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May 30, 2026 08:00 ET (12:00 GMT)

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