Remember when investors were dreaming of rate cuts? Yeah, about that. Those dreams are officially dead, and the Strait of Hormuz is the murder weapon.
Back in January, Wall Street was practically giddy. The Fed was supposed to be dovish, inflation was cooling, and everyone was betting on two or three juicy rate cuts in 2026. Fast forward to now, and the CME Fedwatch tool is showing a 74% chance that rates stay frozen at 3.5%-3.75% through December. That’s a wild swing from the 5% odds investors were giving that scenario just a couple months ago.
What happened? Oil happened. When the US and Israel started striking Iran’s military infrastructure, Iran basically said “fine, we’re closing the Strait of Hormuz” and sent global oil supplies into chaos. Brent crude is up over 40% since the war kicked off. Sure, Trump’s been making noises about “productive talks” with Iran, and oil prices have cooled a bit, but the damage to investor expectations is already done.
Here’s the thing: higher oil prices mean higher gas prices, which means inflation fears are back on the menu. And when the Fed gets nervous about inflation, it doesn’t cut rates—it holds steady or even hikes. Chicago Fed President Austan Goolsbee basically confirmed this on Monday, hinting that rate hikes are actually on the table if inflation gets “out of control.”
This is a problem because the entire bull case for stocks has been built on the foundation of falling rates. Lower rates make future corporate earnings worth more today, which is supposed to push stock prices higher. No rate cuts? That’s a key pillar of the bullish thesis getting kicked out.
But here’s where it gets interesting: Deutsche Bank analysts think the Fed might be overcorrecting anyway. They’re pointing out that central banks have a habit of learning the wrong lessons from the last crisis. After the 2008 financial crisis, the Fed was too loose. After COVID, it was way too loose. Now, with memories of 2021-2022’s inflation disaster still fresh, the Fed is probably going to be extra hawkish about any inflation spike—even if it’s just temporary oil-driven stuff.
As Henry Allen from Deutsche Bank put it, central banks are basically trying to avoid getting roasted for being too relaxed about inflation. So even if the Iran situation calms down, the Fed might stay stubborn about rate cuts just to prove it’s serious about fighting inflation.
Fed Chair Jerome Powell made it crystal clear at last week’s meeting: if inflation doesn’t cooperate, there won’t be rate cuts. Period.
The bottom line? Investors were betting on a free lunch—lower rates without having to worry about inflation. The Iran war just served notice that free lunches are off the menu. For now, the Strait of Hormuz is still closed, oil is still elevated, and rate cuts are still a fantasy.
