Odds surge for hike as oil rips higher

Investors are increasingly preparing for the Federal Reserve to hike interest rates as oil prices climb.

Fed funds futures are pricing in a roughly 82% likelihood that the central bank lifts borrowing costs at its September policy meeting, according to CME’s FedWatch tool. A week ago, those odds sat below 53%.

The central bank is still broadly expected to keep rates unchanged at the current 3.50% to 3.75% at its gathering next week. But even then, there’s a growing minority planning for an increase: Fed funds futures trading indicates a nearly 38% probability of a quarter percentage point hike, up from less than 12% a week ago.

Brent, the global crude benchmark, hit $100 a barrel on Thursday for the first time since late May amid a new round of tit-for-tat attacks between the U.S. and Iran. The average price for a gallon of gasoline in the U.S. reached $4 per gallon this week — the highest in more than a month, according to AAA.

Thursday’s employment data bolstered the view that the Fed can focus more on inflation — which could accelerate as energy prices climb — than the health of the labor market.

Initial jobless claims dropped to 187,000 in the week ended July 18, the Labor Department reported. That was the fewest claims since 1969, when the U.S. population was 60% of what it is today.

“At the moment, the outlook for economic growth is showing some signs of overheating if today’s weekly jobless claims figures can be believed,” said Christopher Rupkey, chief economist at FWDBONDS. “But for how long is the question if energy prices continue to spiral upward.”

Rising expectations for a rate increase may be adding to the downward pressure on the stock market Thursday, according to Larry Tentarelli, chief technical strategist at the Blue Chip Daily Trend Report. That’s on top of the breakout in oil prices and Treasury yields, and Alphabet‘s post-earnings swoon, he said.

The blue-chip Dow Jones Industrial Average tumbled about 500 points. The Nasdaq Composite — heavily weighted to technology stocks that can be sensitive to higher borrowing costs — shed more than 2%.

“You really just have a perfect storm of headwinds right now,” Tentarelli said.

“We’ve got a Fed meeting in six days, and I think investors should not be in a hurry to buy anything,” he added. “There’s times where you can just sit it out and be patient.”

‘A readthrough’

Market participants looking for insights into the Fed’s outlook are closely monitoring the 2-year U.S. Treasury yield. The yield, which rose about 5 basis points on Thursday, offers “a readthrough on what the Fed might do next,” said Ross Mayfield, an investment strategist at Baird.

While Mayfield said investors don’t need to worry about an interest rate move next week, September feels like a “live” meeting for the Fed.

Kalshi traders have similarly increased their bets of a September quarter point increase in recent days. Odds of such a move at that meeting rose to 48% midday on Thursday, up from about 30% a week ago.

To be sure, economists’ interest rate outlook through 2026 doesn’t signal an environment with tighter monetary policy.

The consensus forecast remains that the Fed won’t hike rates this year, according to FactSet. In 2027, economists anticipate the central bank will lower borrowing costs by half a percentage point.

— With additional reporting by CNBC’s Sean Conlon