Not in the clear yet: Investors are starting to expect rate hikes that could hurt stocks

• The narrative around the Fed's next move has quickly flipped.
• Markets are now pricing a higher probability of a rate hike than a cut.
• Despite a sharp relief rally on Monday, plenty of inflationary risk lingers amid a historic disruption of oil.

I know this is well-traveled territory at this point, but man, President Trump's Truth Social account is ridiculously powerful.

In one post, the president said the US was in "constructive" talks with Iran, and announced a five-day postponement of further attacks. In a flash, US stocks posted immediate gains of more than 2%. Brent crude — which had hovered stubbornly above $100 for more than a week — dropped 10%.

The reaction makes sense when you consider what energy consultant Bob McNally told BI last week: Investors are being driven by confirmation bias. They want Iran-war volatility to subside, so when they get a glimmer of hope, they lean into trades that support that.

The fact that Iran came out and challenged Trump's claim of open talks — which knocked stocks down from intraday highs and caused oil declines to pare — shows just how uncertain the situation still is. Sentiment can flip on a dime. One social media post didn't solve the war.

Let's take a deep breath and step back. Remember when, at the beginning of the Iran war, everyone warned that it wasn't $100 oil that would roil markets — it was a prolonged stretch above $100?

Well, the fallout is getting more pronounced, and we may be past the point of no return for a major piece of the bull argument for stocks: rate cuts.

The Fed's decision to cut three times in the final months of 2025 coincided with a series of record highs in stock indexes. Forecasts were bright for 2026 because Wall Street expected more of them. It's what the central bank itself was signaling.

No longer. Late last week, the bond market was officially pricing in zero cuts for 2026. CME Group's FedWatch tool shows just a 17% chance of one by year-end.

All the while, one of the stock market's foremost enemies — rate hikes — has suddenly entered the chat. It's a huge development, and one that doesn't bode particularly well for the near-term future of equities. Rate cuts are rocket fuel for earnings growth, and investors tend to throw a fit when they feel deprived.

The chart below shows that investors are now assigning a higher probability of a rate hike than a cut:

The main culprit is the inflation that the Iran war has wrought in the energy market and more broadly. Even if the US and Iran announce a complete end to the war, the effects of the biggest oil disruption in history will linger.

Strategists at Deutsche Bank expect a sharp US reaction to any inflation that transpires. They note that policymakers underestimated past surges, and will likely overcorrect with hawkishness this time around.

And if there was any question that the Fed might consider a rate hike, Chicago Fed President Austan Goolsbee put that to rest on Monday. While hiking isn't part of his base case, he did say it's a possibility if inflation becomes a persistent issue.

So enjoy Monday's bounce back in stocks while you can. Between the oil market, inflation, and the prospect of rate hikes, the market still has many unresolved issues that could end up biting.