A week-long surge of 30 percentage points: Why is the market suddenly betting on a Fed rate hike in September?

Key takeaways: CME FedWatch data show that, as of July 23, the market-implied probability of a Fed rate hike in September has risen to 82%, compared with less than 53% one week ago; even at the July 29 FOMC meeting itself, the implied probability of a 25-basis-point hike jumped from under 12% to 38%. However, the driver of this repricing is not economic overheating, but energy inflation lifted by a Middle East geopolitical conflict—this is risk-premium repricing, not growth-premium repricing, and the transmission logic to assets is completely different.

I. Background

Since taking office on May 22, the newly appointed Fed chair, Warsh, has consistently stressed “zero tolerance” for inflation. He did not submit individual economic forecasts at the June FOMC meeting, but the minutes released after the meeting on July 8 show that among 18 officials, half supported another rate hike within the year, while the other half leaned toward holding rates unchanged or cutting—inside the committee, disagreement is rarely as close to a 50-50 split. At the July 14 congressional hearing, Warsh reiterated “we’ve already missed the 5-year target in a row—this time we’re correcting it,” with clear hawkish signaling, but he did not provide a specific path.

II. Data and logic

The direct trigger for the probability surge this time is oil prices. Yemen’s Houthi forces claimed attacks on two Saudi oil tankers in the Red Sea area, while Trump also threatened to strike Iran’s infrastructure. Brent crude returned to $78 per barrel, clearly above the roughly $70 level before the conflict, and it had previously once approached $100. The pass-through from energy costs to CPI has been immediate: May core PCE year-over-year rose to 3.4%, the highest since October 2023, and the 63rd consecutive month above the 2% target; May headline CPI briefly climbed to a three-year high of 4.2%.

But it’s worth noting the divergence signal: the June CPI data actually fell short of earlier expectations and came in softer, dropping to 3.5%; core CPI fell to 2.6%, and the month-on-month figure saw the largest single-month decline since May 2020. This indicates that after stripping out geopolitical shocks, underlying inflation pressure has been easing.

JPMorgan’s team believes the Fed will keep rates unchanged throughout all of 2026, and the next move may not be a hike until the third quarter of 2027—this is sharply at odds with the market’s current hawkish repricing. The economists’ consensus in a FactSet survey also leans toward no hikes within the year.

On July 24, the latest trading day, as the Middle East situation eased temporarily, oil prices pulled back. The S&P 500 rebounded 0.6%, suggesting that the volatility behind the spike in rate-hike probabilities is huge in itself: it reflects a rapid repricing of tail risks by hedge funds and the futures market, rather than a reassessment of economic fundamentals.

III. Impact

For liquidity conditions, if September truly turns into a hawkish hiking scenario, it would mark the first time since 2023 that the Fed reboots a hiking cycle. The pressure on high-valuation growth stocks and long-duration assets would be significantly greater than the pressure on value stocks and short-duration assets. For the US dollar and gold, stronger hawkish expectations are typically bullish for the dollar and weigh on gold in the short term; but if the hikes are fundamentally a passive response to supply-shock-driven inflation (oil-price driven) rather than demand overheating, the market’s pricing logic for “stagflation trades” may become more complex. Historically, gold’s safe-haven attributes in stagflation environments could instead be reactivated.

IV. Outlook and risk warning

The key variable in the current setup is the evolution path of the Middle East conflict, not US domestic demand or employment data—this is fundamentally different from the driving logic behind the 2022 hiking cycle. If the situation in Iran cools further and oil falls back below $70, the probability of a September hike would very likely retreat significantly in tandem—this is also a sign that already appeared on July 24. Conversely, if the conflict escalates and oil prices again approach $100, with input-driven inflation pressure layered on top of elevated core PCE, it could force the FOMC under Warsh to take a hawkish action beyond what the current market consensus expects.

A reminder: CME FedWatch probabilities are based on market-implied expectations from futures pricing. In essence, they are traders’ risk pricing and do not equal the Fed’s true decision path. Historically, it is not uncommon to see the market’s short-term pricing of Fed decisions swing sharply and then be corrected quickly. Volatility in energy prices driven by geopolitics carries a high degree of uncertainty. It is advisable to continue monitoring Brent crude’s price trend, the August CPI/PCE data, and Warsh’s statements at (if held) the Jackson Hole meeting, as key checkpoints to validate or falsify the current market pricing. DYOR.