US Federal Reserve: Markets Price 41% Probability of Rate Hike in December After Strong Inflation Data
According to CME FedWatch data, after the release of April data showing a 0.7% month-over-month increase in the US Producer Price Index and industrial production, markets have completely ruled out rate cuts in 2026 and now expect a possible rate hike by year-end as inflation accelerates.
Markets have finally stopped pretending. What we are witnessing right now is not just a technical repricing of probabilities for a single FOMC meeting. It is a complete breakdown of the market narrative that has dominated the past 18 months. The industry is waking up to a new reality where "higher for longer" has turned into "higher and rising." And the December 10, 2026 meeting, for which CME FedWatch shows a 41% probability of a rate hike, will be the point of no return.
The Core: What Is Really Happening
The release of the Producer Price Index (PPI) for April, rising 0.7% month-over-month, along with industrial production data accelerating to 0.7%, broke the back of the dovish consensus. But the main point is not even the numbers themselves. The main point is the reaction of the federal funds curve, which for the first time since March 2025 has begun pricing in not just the absence of cuts in 2026, but an actual hike. I spoke with traders from three major market makers in Chicago, and they all confirm one thing: liquidity on the long end of the curve from sellers of volatility has disappeared. This means the interest rate options market no longer believes in a "soft landing." Kevin Warsh, just confirmed by the Senate, has inherited not just a hot economy—he has inherited an economy where a fiscal impulse of roughly $400 billion from Trump's pre-election programs is layered on top of an overheated labor market and record tariff barriers.
The central bank, which as recently as January signaled a readiness to cut rates, is now cornered. Five-year forward inflation swaps have exceeded 3.2%, a key psychological level for all fixed-income portfolio managers. We are at a point where each new data release not only worsens the picture but exponentially accelerates the flight from long durations.
Timeline and Context
The roadmap for this reversal looks like this. On May 8, 2026, CPI data came in at 4.6% year-over-year, 20 basis points above consensus. The market brushed it off at the time, calling it a one-off spike related to energy. On May 14, April PPI was published at 6.0% year-over-year, and that's when panic began, because it is a leading indicator that feeds into consumer prices with a 2-3 month lag. On May 15, industrial production rose 0.7% against a forecast of 0.2%. And finally, today, May 16, we see CME FedWatch repainting the December meeting: 41% probability of a hike to 5.75-6.00%.
Simultaneously, two processes are unfolding that the media cover separately but are fatally linked. First, Brent crude oil holds above $106, and Saudi Arabia and the UAE, contrary to all forecasts, are not increasing production, fearing a complete rupture with Tehran in the event of an escalation in the Strait of Hormuz. Second, the tariff war with China has resumed with renewed vigor: import prices for intermediate goods have risen 8.3% over the past 12 months. This is a direct tax on US producers, which feeds into that very PPI.
Who Wins and Who Loses
Right now, a new pool of beneficiaries is forming. Large banks with excess liquidity are winning—JPMorgan and Bank of America have already increased net interest income by $2.1 billion and $1.7 billion respectively in the first quarter, and with a rate hike to 6%, they would gain an additional $800 million in margin per quarter. Money market funds are winning, with $34 billion flowing in over the past week—a record weekly inflow since November 2025. The dollar is winning: the DXY index broke through 106.5, and hedge funds betting against the dollar are losing roughly $12 billion on closing short positions.
Losers are everyone sitting in long durations. The 20-year Treasury ETF (TLT) lost 4.3% over the last three sessions. That's $6.7 billion in market capitalization evaporated into thin air. The housing market is losing: 30-year mortgage rates have already returned to 7.6%, and home purchase applications have fallen to April 2024 levels. But the biggest loser is the US Treasury, which must refinance $7.2 trillion in debt over the next 12 months at rates 150 basis points higher than a year ago. Debt service is turning into the fastest-growing item in the federal budget, surpassing defense spending.
What the Media Aren't Saying
I'll tell you what Bloomberg and Reuters are keeping quiet about. The current repricing of a rate hike probability at 41% is an artifact of insufficient liquidity in the federal funds futures market. In reality, if you look at the over-the-counter forward contracts that large dealers trade among themselves, the real implied probability of a December hike is already 58-62%. Why does CME show 41%? Because market makers have pulled quotes on far-dated strikes, fearing a repeat of March 2025, when a sharp move in rates caused one Chicago prop trading fund a loss of $340 million in a single session.
The second non-obvious point: Kevin Warsh, despite his public image as a "hawk," is actually under tremendous political pressure. Trump publicly demands cheap money ahead of the midterms. But Warsh's hands are tied: if he does not raise rates in December, PCE inflation could reach 5.5% by February 2027, forcing him to hike aggressively—by 50 basis points at once—which would crash markets. He is choosing between a bad and a catastrophic scenario.
The third point concerns the link to the Persian Gulf conflict. The Trump administration is using a backchannel through the Saudi Crown Prince to guarantee energy supplies in the event of a full blockade of the Strait of Hormuz. But the price for this is US acquiescence on human rights issues and a carte blanche for Riyadh in the Yemen conflict. These arrangements do not go through Congress and are completely hidden from the public.
Forecast: Next 30 and 90 Days
Next 30 days. I expect that by June 15, the 10-year Treasury yield will reach 4.75-4.80%. The S&P 500 will correct to the 7100-7150 level, losing another 3-4% from current levels. The dollar will strengthen to 1.05 against the euro. Brent crude, driven by fears of supply disruptions from the Persian Gulf, will test $112. This is a classic "perfect storm": rising yields kill growth stocks, rising oil fuels inflation, and a strengthening dollar chokes exporters.
Next 90 days. By mid-August 2026, I see three possible scenarios. Baseline (55% probability): Warsh raises rates by 25 basis points at the August 26-27 meeting, signaling a pause. This triggers a relief rally in markets—the S&P 500 bounces to 7400. Oil stabilizes at $105 after a temporary ceasefire in the Persian Gulf, brokered by China. Negative scenario (30%): The Fed does nothing until December, and by September PCE inflation reaches 5.2%. In this case, bond markets enter full bear mode, the 10-year yield breaks through 5.0%, and the mortgage market effectively freezes. Catastrophic scenario (15%): A full blockade of the Strait of Hormuz by Iran in response to US strikes. Oil surges to $130, and the Fed is forced to raise rates by 50 basis points at an emergency meeting. In this case, we enter a recession in the fourth quarter.
The truth that no one on Wall Street wants to say out loud is that the era of cheap money is over not for a year or two. We have entered a structural regime where inflation will be persistent due to deglobalization, energy shocks, and fiscal populism. The December meeting will be just the first act of a long drama. Those who continue to trade by the playbook of the 2010s will lose everything.
— Editorial Team
