Something unusual is unfolding in inflation and interest-rate markets.

As oil prices surpass $100 a barrel amid the closure of the Strait of Hormuz, a sharp contradiction is being priced in real time across prediction markets.

On one hand, traders are rapidly pricing a surge in inflation this month. On the other, they are still betting the Federal Reserve will move ahead with interest rate cuts in 2026.

Can the two predictions really hold simultaneously?

A Market Betting On ‘Transitory’ Again

Beneath the surface, markets appear to be resurrecting a word that defined the inflation debate in 2021: “transitory.”

According to Polymarket, the probability that the annual inflation rate for March will exceed 2.8% has jumped by about 45 percentage points to roughly 87%.

That sharp move suggests traders expect inflation to rise meaningfully from the current 2.4% level and drift further away from the Federal Reserve's 2% target.

Yet the interest-rate outlook tells a very different story.

Chart: The Inflation Signal That Moved 45 Points Overnight

Rate-Cut Bets Have Not Broken

Markets still heavily expect the Federal Reserve to cut rates this year.

Notably, the implied probability of at least one rate cut stands at 75%.

Prediction market data show a 28% probability of a single rate cut of 25 basis points this year. The probability of two cuts is also about 28%, while traders assign a 15% chance to three cuts and a 4% chance to four cuts.

Meanwhile, the probability of no rate cuts is only about 18%. Even lower than that, the odds of a Federal Reserve rate hike in 2026 remain at roughly 14%.

That is not a market pricing a 1970s scenario.

That is a market pricing a 2021 scenario, with the Fed looking through the energy surge and resuming its cutting path once the shock fades.

The $100 Crude Threshold: How Can It Change Inflation And Interest Rates?

Crude oil prices are once again climbing toward levels historically associated with inflation risk.

Several Federal Reserve tightening cycles followed energy-driven inflation spikes, including those associated with the oil shocks of the 1970s, the Gulf War in 1990 and the post-pandemic energy crisis in 2022.

In a note published Monday, Bank of America economist Claudio Irigoyen framed the inflation-oil relationship with unusual precision: history does not support a simple pass-through from higher oil to sustained inflation.

"While market and survey-based inflation expectations can be sensitive to oil at high frequency, history suggests only marked and persistent spikes in the price of crude trigger persistent inflationary cycles," Irigoyen said.

“Our base case is that the Iran conflict will not affect the trajectory of Fed policy, though it will probably strengthen the consensus around staying on hold at the next two meetings,” Irigoyen added.  

However, the outlook would change if oil prices remain elevated for an extended period.

An escalation that keeps crude prices above $100 per barrel could become far more concerning.

“Some policymakers might even call for hikes if inflation expectations, which are typically sensitive to oil prices, were to move up meaningfully. But we think the bar to raise rates will be high under Warsh,” Bank of America said.

Three Risks For The US Economy From An Energy Shock

Irigoyen identified three distinct channels through which a $100-plus crude environment would become genuinely dangerous, rather than merely uncomfortable.

First, higher oil prices could tighten financial conditions.

Spending growth in the United States is currently driven largely by higher-income households that benefited from the near doubling of stock markets over the past three years. A prolonged equity market downturn could weigh heavily on their spending.

Second, lower-income households face greater exposure to energy costs because fuel represents a larger share of their spending. Further increases in fuel prices could push delinquencies higher, particularly in credit cards and auto loans.

Third, rising energy costs could become a bottleneck for investment in artificial intelligence.

Large technology firms including Amazon.com Inc. (NASDAQ:AMZN), Microsoft Corp. (NYSE:MSFT) and Alphabet Inc. (NASDAQ:GOOGL) have announced massive data center investment plans. Higher energy prices could delay those projects and reduce a key growth driver for 2026.

Bank of America also warned that “the cumulation of shocks also starts to increase our concerns around non-linear effects.”

For now, markets appear convinced the energy shock will not derail the Federal Reserve's easing path.

But history suggests that when energy markets move violently, the inflation outlook can change much faster than investors expect.

Whether this episode proves temporary — or the beginning of something more persistent — is the question markets are now pricing in real time.

Image created using artificial intelligence via Midjourney.