Gas prices displayed at a Mobil gas station in Pasadena, California on March 30, 2026.
Tama Mario | Getty Images
As part of an ongoing supply shock in energy markets, gasoline prices above $4 a gallon may appear to be a signal for the Federal Reserve to raise interest rates to stem inflation. That seems like a bad bet, at least for now.
Instead, investors expect the central bank to keep rates unchanged or even cut them later this year, as policymakers consider the risk that rising energy prices will slow growth rather than sustaining inflation.
In market-moving remarks, Federal Reserve Chairman Jerome Powell suggested on Monday that raising interest rates now could be the wrong medicine for an economy already facing softening labor conditions and growing recession fears on Wall Street.
Asked whether he thought policymakers should consider raising interest rates now, Powell said: “By the time monetary tightening takes effect, the oil price shock will probably be long gone and you’re putting pressure on the economy at the wrong time. So we tend to look at any kind of supply shock.”
The comments come at a critical juncture for markets, which are struggling to grasp the Fed’s intentions amid a swirl of conflicting and ever-changing economic indicators.
Just a few days ago, traders started worrying that the Fed’s next move could be to raise interest rates. This thinking followed some worrying inflation news. Import prices in February were much higher than expected in the face of war-related oil price increases, while the OECD significantly raised its US inflation forecast to 4.2% in 2026.
But Powell’s comments, with the usual Fed qualifier that both rate hikes and rate cuts are possible, helped bring the market back from its hawkish stance. Before the war, markets had expected two or even three rate cuts this year in anticipation of inflation continuing to return to the Fed’s 2% target and central bank officials shifting their focus to supporting the labor market.
Futures prices as of Tuesday morning showed a mere 2.1% chance of a rate hike by the end of the year, according to CME Group’s FedWatch tool. That’s despite headlines reporting that regular unleaded gasoline is more than $4 at the pump nationwide and that U.S. crude oil prices are more than $102 per barrel.
Although there is still much uncertainty about the future of interest rates, Wall Street commentary has returned to expectations for rate cuts. Admittedly, the probability of a reduction is still low, around 25%, but it has increased significantly in the past two days.
inflation and growth
Rob Subbaraman, Nomura’s head of global macro research, wrote that “central bankers’ barks will be louder than their mouths” when it comes to combating soaring prices.
“At this point, with headline inflation soaring, it makes sense for central banks to do nothing more than take a hawkish stance to entrench inflation expectations,” he added. “However…the spillovers to wage growth and core inflation are likely to be limited, and instead the Middle East war could quickly turn into a global growth shock.”
Indeed, concerns about the impact of rising oil prices on growth outweighed concerns about consumer prices, echoing Powell’s concerns that raising interest rates now would not solve energy costs and could cause more problems later. Policymakers are more concerned about the risk that higher prices could hurt consumer demand and jobs than the immediate hit from energy-driven inflation.
RSM chief economist Joseph Brusuelas said central bankers should fear “demand destruction” caused by energy shocks.
“Time is not on the side of the American economy,” he wrote. “What comes next is a bigger risk: demand destruction. It’s an economic term that describes what happens when people and businesses spend less because of high prices. It sounds abstract, but it’s very concrete. That means fewer car sales, fewer home purchases, fewer restaurant meals, less business investment, and ultimately fewer jobs.”
Brusuelas added that the Fed is in a policy bind. “Raising interest rates risks further slowing economic growth, and maintaining the status quo could worsen the oil situation further.”
“This is a classic stagflation dilemma, and there is no clear answer,” he said. “If the situation becomes more serious, the Fed will act. But we think the Fed is likely to act patiently and, if it does act, it will likely be late and put more pressure on demand before cutting rates aggressively.”
Jason Thomas, a strategist at Carlyle Group, echoed those concerns, saying not only could the Fed be forced to cut rates, but it might also need to act more aggressively than its usual quarter-point step.
The move highlights a shift in the way the Fed responds to shocks. In other words, they are focusing on the broader economic impact while overcoming temporary price spikes.
“The Fed is not sitting idle as temporary supply shocks hit the labor market,” said Thomas, head of global research for investment strategies at the firm. “In this economic downturn scenario, rate cuts could occur as early as September, and rate cuts are likely to occur in increments of more than 25 (basis points).”
