Forget Rate Cuts. The Fed Might End Up Hiking Rates This Year.

Key Points

Some Fed officials are beginning to hint at the possibility of a rate hike in the coming months.

The bond market also sees higher interest rates ahead -- a prospect that investors should monitor.

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Just a month ago, it looked like the stock market could look forward to two or even three interest rate cuts this year. Such cuts almost always boost share prices.

Today, however, the futures market sees a 78% chance that the Federal Reserve will make zero cuts in 2026. Worse, the idea is beginning to creep up that the Fed's next policy move will be a rate hike, not a cut. Cleveland Federal Reserve President Beth Hammack recently said she thinks a rate hike is possible this year. "I could see where we might need to raise rates if inflation stays persistently above our target," Hammack said in an interview with The Associated Press this month.

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She's not the only Fed official to see it that way. Last month, Austan Goolsbee, president of the Chicago Fed, said that "rate increases have to be on the table" if inflation ticks up in the coming months. And a recent release of minutes of the Fed's January meeting show that 19 Fed officials on the rate-setting committee wanted the Fed's statement to reflect the possibility of rate hikes.

So what does this all mean for long-term investors?

We're likely to see an uptick in inflation in the March CPI report

An uptick in inflation is very likely to show up in Friday's Consumer Price Index report, which will be published before the market opens on April 10. The Cleveland Fed estimates that headline inflation jumped 0.84% month over month in March, which would be a huge increase.

A Fed hike in response to rising inflation is not yet reflected in Fed funds futures markets. Right now, futures traders are assigning just a 1% or so chance of that happening.

But expectations of a hike are indicated by the yield of the two-year Treasury note. That yield is very sensitive to monetary policy, and right now it's trading above the effective Fed funds rate, suggesting that bond traders expect a higher Fed funds rate in the near future.

If the Fed does decide to hike its benchmark interest rate this year, it will certainly rock the stock market. Because when the Fed is raising rates -- also known as tightening the money supply -- risk assets like stocks tend to fare poorly.

That's what makes Friday's CPI report so critical. Many traders will automatically reduce their exposure to equities if inflation comes in higher than expected, because they'll expect the Fed to raise rates this year. Thus, the phrase, "Don't fight the Fed."

Investors can prepare for higher interest rates by avoiding stocks of companies that borrow heavily, especially real estate investment trusts, and overweighting financial stocks, which will see an increase in their net interest margins -- the difference between what they earn on loans and pay on deposits.

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