Rate hikes might be back on the table after the U.S.-Iran failed talks. The likelihood comes after months of what many thought to be a soft landing.
But the fresh uncertainty around the Iran war has now sent shockwaves through global markets, with major advanced economies following a cautious approach towards the 2% target inflation rate.
Interest rate cuts ahead of easing inflation
In the past, the Fed has shown that it doesn’t have to wait for the inflation to hit the exact 2% target.
That’s because the central bank policy works with “long and variable lags” and not in real time.
This explains why in September 2025, the Fed began cutting rates even though its core PCE inflation was around 2.8%, well above its 2% target. The decision to cut interest rates was taken because by the time inflation fell to 2%, the economy could already be slowing.
In other words, if the Fed acts preemptively to cut rates to avoid a recession, it surely will act preemptively to raise rates to curb inflation.
Why a 2026 rate hike is back on the table?
With uncertainty brewing, most central banks are pausing any rushed interest rate decisions, not because 2% has been reached, but because the path forward is unclear.
The Fed looks at core PCE inflation and employment data, a dual mandate to promote maximum employment and maintain low and stable inflation. But that doesn’t mean ignoring the headline inflation.
Headline inflation captures the change over month and year for a certain category and by diving deep into the numbers, it is easy to gauge where prices went up or what contributed to a change in the headline inflation.
An example is the recent Consumer Price Index data released by the U.S. Bureau of Labor Statistics, which clearly indicates that energy prices rose by 12.5% year-over-year change in March 2026. The spike was exceptionally high over the month with energy index at 10.9%, which is the largest single-month increase in over 20 years (since the Hurricane Katrina spike in September 2005.)
The price volatility is also captured in real-time in oil prices, a metric most global central banks are keeping a close watch on. The oil futures have been exceptionally sensitive to the tensions in the Middle East. In the past, the Fed had not actively looked at markets when making an interest rate decision. But global interdependence and interconnectivity through trade flows has shown that markets can never be ignored during central bank’s monetary policy decisions.
Bottom line
How the Iran war unfolds will depend on how strong the ceasefire holds and this will be captured in the oil prices, a commodity market closely tied to this war.
The lag effect will of course be captured in the next April inflation data that gets released on May 12, 2026.