Gas prices are displayed at a Mobil gas station on March 30, 2026 in Pasadena, California.
Mario Tama | Getty Images
Gasoline prices over $4 a gallon, part of an ongoing supply shock in the energy markets, might seem like a cue for the Federal Reserve to raise interest rates to head off inflation. At least for now, that looks like a bad bet.
Investors instead expect the central bank to hold benchmark rates steady, or even pivot back toward cuts later in the year as policymakers weigh the risk that higher energy prices will slow growth more than they fuel lasting inflation.
In market-moving remarks Monday, Fed Chair Jerome Powell signaled that raising rates now could be the wrong medicine for an economy already facing a softening labor backdrop and elevated recession concerns on Wall Street.
Asked whether he thought policymakers should consider rate increases here, Powell responded: “By the time the effects of a tightening in monetary policy take effect, the oil price shock is probably long gone, and you’re weighing on the economy at a time when it’s not appropriate. So the tendency is to look through any kind of a supply shock.”
The comments come at a critical juncture for markets, which have struggled to get a handle on the Fed’s intentions amid a bevy of conflicting and perpetually shifting economic signals.
Just a few days ago, traders began to entertain the possibility that the Fed’s next move could be hike. That mindset followed some unsettling inflation news: Import prices rose much more than expected in February, even ahead of the war-related oil spike, while the OECD raised its U.S. inflation forecast dramatically, to 4.2% for 2026.
However, Powell’s comments — complete with the usual Fed qualifiers that there potential cases for both hikes or cuts — helped bring the market back off the hawkish position. Prior to the war, markets had been looking for two and possibly even three cuts this year in anticipation that inflation could continue to drift back to the Fed’s 2% target and central bankers would switch their focus to supporting the labor market.
Futures prices Tuesday morning pointed to just a 2.1% chance of a rate hike by year-end, per the CME Group’s FedWatch tool. That’s despite headlines noting that regular unleaded gasoline had eclipsed $4 nationally at the pump and U.S. crude oil priced above $102 a barrel.
While there’s still plenty of uncertainty about where rates are headed, Wall Street commentary shifted back to expectations for cuts. To be sure, odds are still low for a reduction — about 25% — but they have climbed considerably over the past two days.
Inflation vs. growth
“Central bankers’ bark will be bigger than their bite” when it comes to fighting higher prices, wrote Rob Subbaraman, head of global macro research at Nomura.
“Right now, it makes sense for central banks to do nothing but sound hawkish in order to help anchor inflation expectations as headline inflation spikes,” he added. “However … the pass-through to wage growth and core inflation is likely to be limited, and instead the Middle East war could quickly morph into a global growth shock.”
Indeed, concerns about the impact that the oil price spike will have on growth superseded the worries about consumer prices, echoing Powell’s worry that hiking now won’t fix energy costs and could cause more trouble later. Policymakers are worried less about the immediate hit from energy-driven inflation than the risks that higher prices could sap consumer demand and hiring.
Joseph Brusuelas, chief economist at RSM, said central bankers should fear “demand destruction” brought on by the energy shock.
“Time is not an ally of the American economy,” he wrote. “The bigger risk is what comes next: demand destruction. That’s the economic term for what happens when high prices force people and businesses to spend less. It sounds abstract, but it’s very concrete — it means fewer cars sold, fewer homes bought, fewer restaurant meals, fewer business investments, and eventually fewer jobs.”
The Fed is in a bind policy-wise, Brusuelas added: Raising rates now risks slowing economic growth further, while standing put runs the chance that the oil situation gets worse.
“This is the classic stagflation dilemma, and there’s no clean answer,” he said. “If the situation becomes more severe, the Fed will act. But we think more likely than not that the Fed remains patient and when it does act it will be behind the curve, adding further pressure on demand before cutting aggressively.”
Carlyle Group strategist Jason Thomas echoed those concerns, saying that not only might the Fed be forced to cut, but it also may have to move more aggressively than its typical quarter percentage point stages.
The dynamic underscores a shift in how the Fed responds to shocks — looking past temporary price spikes while focusing more on the broader economic fallout.
“This is not a Fed that will sit by idly as a temporary supply shock hammers the labor market,” wrote Thomas, the firm’s head of global research at investment strategy. “In this downside economic scenario, rate cuts could arrive as soon as September. And they’re likely to come in greater than 25 [basis point] increments.”
