Three Key Conditions Needed for Fed Rate Hikes as US-Iran Conflict Fuels Inflation Risks

• Markets price Fed hike risk above 30% as oil-driven inflation concerns intensify.
• BofA flags labor stability, core inflation, and Powell continuity as key triggers.
• Rate cuts in 2026 are still seen as more likely if oil pressure and inflation ease.

Rising geopolitical tensions tied to the U.S.-Iran conflict are affecting expectations for Federal Reserve policy, as surging oil prices raise concerns. Wall Street is questioning whether the central bank could shift from its current stance toward possible rate hikes.

According to Bank of America, while such a move remains possible, it would require a specific combination of economic and policy conditions to materialize. Market pricing already reflects growing uncertainty, with traders assigning more than a 30% probability to a rate hike by year-end, while expectations for rate cuts have dropped to 6.1%.

Market Volatility Reflects Policy Uncertainty

Financial markets have reacted to the shifting outlook. U.S. equities have recorded a fourth consecutive weekly decline, marking the longest losing streak in a year. At the same time, bond markets have come under pressure, with the 10-year Treasury yield rising by 13.4 basis points during the week. The 5-year Treasury yield has also surged above 4% for the first time since July.

These movements follow growing concerns that higher energy prices, driven by disruptions in the Strait of Hormuz, could feed into broader inflation. Bank of America noted that the impact on inflation has so far been concentrated in energy markets.

Related: Arthur Hayes Says Iran Conflict Could Trigger Fed Easing, Boost Bitcoin

Three Conditions for a Rate Hike

Bank of America outlined three prerequisites that would need to be satisfied before the Federal Reserve considers raising interest rates.

First, the labor market must remain stable. The bank pointed out that policymakers would require assurance that employment conditions can withstand tighter monetary policy. Specifically, the U.S. unemployment rate would need to stay below 4.5%.

Second, inflation would need to intensify beyond energy-related effects. The Federal Reserve would look for sustained increases in core inflation, rather than temporary price spikes tied to oil. Analysts noted that while current disruptions have had a limited impact, sustained energy price strength could spread inflation across multiple sectors.

In addition, leadership continuity at the Federal Reserve is seen as a key factor. Jerome Powell’s term as Chair is set to expire in May, and his potential continuation would influence policy direction. Bank of America described Powell as a “moderate dove,” with a tendency to prioritize labor market stability when risks are balanced.

Despite elevated risks, Bank of America says that rate cuts in 2026 remain more likely than hikes, particularly if oil price pressures ease. 

Related: Global Markets Brace as U.S. Tariffs Data and Fed Events Align