The Fed calibrates the oil shock: PCE at 3.00% and an end to rate cuts in 2026?

The Fed Funds futures market assigns a 98.9% probability that rates will remain in the 3.50% – 3.75% range for a third consecutive meeting. The focus will not be on the decision itself, but on the projections and Powell’s tone, which will shape the path of monetary policy in the coming months.

Financial conditions remain loose despite recent tightening

The market is anticipating that the Iran conflict will generate more inflation and make it harder for the Fed to cut interest rates: currently, Fed Funds futures price in a single 25 basis point cut in 2026, expected in September.

At the same time, longer-dated government bond yields have risen by around 25 basis points since the start of the conflict, in the context of higher deficits and rising funding costs. However, demand remains strong – as reflected in the latest 20-year auction – and although credit spreads and volatility (VIX, MOVE) have increased, there are no signs of elevated stress. Overall, financing conditions remain accommodative.

Will Powell keep a low profile? The impact of oil on the dot plot

This backdrop leaves the Fed in a comfortable position to keep rates unchanged. Powell has room to adopt a more hawkish tone, but he is likely to maintain a cautious, data-dependent approach, avoiding premature reactions to market noise.

The focus will be on the projections, especially PCE and the dot plot. The West Texas Intermediate futures curve points to an average price of $85 for 2026, around $15 above pre-conflict levels. This move could add roughly 0.30 percentage points to PCE directly, and up to 0.50 percentage points when second-round effects are included.

In this scenario, PCE could move back towards 3%, clearly diverging from the 2% target and significantly reducing the likelihood of rate cuts. If confirmed, FOMC members may remove the single rate cut projected for 2026 in their December forecasts.