Why markets may be wrong on rate hikes

The market is likely overpricing a prolonged hiking cycle because it assumes persistently high oil prices without a meaningful hit to growth or a resolution in the Middle East.

• The Federal Reserve raised rates by 25 basis points on 16 September 2026 after inflation had remained above target for 65 consecutive months, while inflation expectations stayed close to 2% and wage growth had fallen from its 2022 peak.
• Since the end of February, the spread between two- and 10-year US Treasury yields has narrowed by 30 basis points as both maturities became more sensitive to WTI oil prices.
• Market pricing implies four further 25-basis-point hikes from the Fed, four from the Bank of England and five from the European Central Bank, taking policy rates to 4.5%, 4.8% and 3.25% respectively.
• The authors believe this path assumes oil prices rise further and remain high, growth stays solid, and more than 100 basis points of tightening does not weaken demand despite falling real incomes.
• They consider a prolonged closure of the Strait of Hormuz 12 months ahead relatively unlikely, while warning that continued oil-price increases should eventually reduce growth expectations.
• Two-year US Treasury yields around 4.7% already price in a 100-basis-point Fed hiking cycle, while the Fed’s long-run rate projection rose by 25 basis points in September.

Takeaway: The market-implied rate path is plausible but appears too aggressive; elevated short-end yields may offer a relatively inexpensive hedge against weaker growth or lower oil prices, although the outlook remains dependent on inflation, energy prices and geopolitical developments.