Rising oil prices boost expectations of rate hikes, and U.S. bond traders' expectations of the Federal Reserve not cutting rates this year are warming.

U.S. Treasury options traders are increasingly betting that the Federal Reserve may not cut interest rates this year. The reason is the ongoing escalation of conflicts in the Middle East, which is driving up oil prices and potentially further increasing inflation.

According to data compiled by the Atlanta Fed, as of Wednesday, traders estimate a 25% chance that the Fed will keep the current interest rate range unchanged through December. This is higher than the 17% probability on last Friday, which was the last trading day before the outbreak of war in Iran.

Among all possible scenarios, “no rate cut for the whole year” has become the most likely single outcome. Other scenarios include a 24% chance of a 25 basis point rate cut once, and a 12% chance of two cuts. Meanwhile, traders even estimate a 16% chance of a rate hike, up from 8% last Friday. These figures are based on SOFR futures options, which are linked to the Federal Reserve’s policy rate.

Industry insiders say, “When oil prices surge, it’s necessary to consider their impact on inflation. This will push inflation upward, reducing the likelihood of the Fed cutting rates.”

Of course, when summing all scenarios, the overall probability still leans toward a rate cut. But recent pricing changes show that, with crude oil prices rising nearly 20% this week, traders’ confidence in the Fed actually lowering borrowing costs this year has significantly declined. The flow of options trading over the past few days also indicates that the market is increasingly hedging against the risk of the Fed reducing easing or not cutting at all.

Another tool used to bet on the Fed’s policy path—the interest rate swap market—also reflects a less dovish stance. Traders now expect about 35 basis points of rate cuts by the end of the year, down from roughly 60 basis points expected last weekend.

The cooling expectations for rate cuts have triggered recent selling of U.S. Treasuries, pushing yields to multi-week highs. This reverses the strong rally in U.S. debt seen in February, when investors flocked to Treasuries for safety amid concerns over AI-related disruptions and cracks in the private credit market.

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