At the start of 2026, the trajectory for global interest rates seemed, if not exactly clear, at least legible. Two Federal Reserve cuts were priced in. The European Central Bank was expected to continue easing. The Bank of England was moving toward accommodation. Central bankers had spent two years taming inflation, and markets had begun to behave accordingly — with two-year Treasuries pricing in a Fed that was on its way down, and rate swap markets reflecting a world that was gradually returning to something resembling normal.
Then, on February 28, the United States and Israel launched airstrikes on Iran, and everything changed almost overnight.
In the five weeks that followed, interest rate swap markets — the vast financial system through which traders, banks, and institutions place and manage their bets on where central bank policy rates are headed — became perhaps the most unstable corner of the global financial system. The Iran war has clouded the outlook for inflation and economic growth in ways that are genuinely difficult to model, and the uncertainty has translated into a level of volatility that most participants in the rates market had not experienced since the post-COVID inflation surge. Rate bets in the US and Europe have been swinging wildly, changing by the minute as the conflict continues, reversals in the ceasefire narrative triggering rapid repricing in both directions.
The most striking shift happened in how quickly the market reconsidered whether central banks would cut rates at all in 2026 — and whether some might, in fact, have to raise them.
From Rate Cuts to Rate Hikes in a Matter of Weeks
Before the war, market consensus had priced in two Federal Reserve rate cuts in 2026. That expectation was built on a reasonable set of assumptions: inflation had been trending down, the labour market was resilient but not overheating, and the Fed had room to ease policy modestly without reigniting price pressures. By mid-March, after the war entered its third week and oil prices had surged above $100 a barrel, those two expected cuts had collapsed to zero — and pricing in some parts of the market had briefly shifted toward a rate hike.
“We’ve seen a dramatic repricing in rate expectations from central banks from a global perspective,” said Madison Faller, executive director of global investment strategy at JPMorgan Private Bank. “Certainly in the US, but some of the more pronounced moves have been around expectations for the European Central Bank and the Bank of England, where we’ve seen a swap from debating rate cuts even into now pricing in rate hikes.”
The Federal Reserve’s March 17-18 meeting took place squarely in the middle of this repricing. The Fed voted 11-1 to keep the benchmark rate at its range of 3.5% to 3.75%, unchanged. Fed Chair Jerome Powell acknowledged the conflict had pushed inflation higher in the near term but insisted it was too soon to judge the full economic impact. The dot plot — the Fed’s official projection of where each member expects rates to go — continued to signal one cut in 2026, though seven of nineteen participants projected no cuts at all, one more than the previous December update. Fed minutes released in April confirmed that a growing number of officials had discussed the possibility that the war might require them to consider raising rates.
The yield on two-year US Treasuries surged to an eight-month high of 3.96% on March 26 — just one month after sitting at 3.38% before the war began — before retreating as the ceasefire announcement on April 7 briefly restored some calm. When the ceasefire was declared, the odds of a Fed cut by year-end jumped from 14% to 43% within hours, according to CME Group’s FedWatch tool. That kind of intraday swing in probability — nearly tripling on a single geopolitical headline — is not normal behaviour for the overnight rate futures market, which in calmer periods tends to move in fractions of a percentage point across weeks.
The Inflation-Versus-Growth Trap
The reason rate markets have become so volatile is that the Iran war presents central banks with a dilemma that has no clean resolution. The conflict is inflationary — directly, through oil and gas prices that feed through into energy bills, transport costs, and food prices. But it is simultaneously deflationary for growth — through the hit to consumer spending as households pay more for energy, the tightening of financial conditions as energy prices raise corporate input costs, and the general dampening of economic activity that war and uncertainty produce.
This is the stagflation dynamic that markets kept circling around throughout March and April, even as officials including Powell explicitly resisted the term. Morningstar senior US economist Preston Caldwell described the current environment as “a double whammy — it’s just the magnitude that’s smaller” than the 1970s. Inflation potentially rising into the 3% to 4% range, GDP growth softening, unemployment not yet clearly rising — this is not a textbook stagflation but it has enough of its features to create genuine policy paralysis.
The Bank of England provided perhaps the clearest articulation of this bind. Governor Andrew Bailey signalled in mid-April that the BOE was in no rush to raise rates despite the inflationary pressure from the oil shock, arguing it was too soon to make a judgment on the overall economic impact. The “length of the war,” he said, would be the key factor. That framing — essentially telling markets “we’re waiting to see” — is honest but it is not clarifying. Rates markets responded by remaining highly volatile around every new development in the Iran ceasefire negotiations.
What the Swings Look Like in Practice
Interest rate swap markets allow participants to exchange fixed interest rate payments for floating payments tied to benchmark rates, effectively letting them bet on the future path of central bank policy. In normal conditions, these markets move slowly and predictably. In March and April 2026, they have moved fast and unpredictably — with each Trump social media post about Iran, each report of failed ceasefire talks, each oil price spike or retreat triggering rapid repositioning across the curve.
The pattern has been consistent: bad war news (talks fail, new strikes threatened, Hormuz remains closed) drives bets toward higher rates or delayed cuts. Good war news (ceasefire extended, diplomatic progress, oil prices fall) restores rate-cut pricing almost immediately. The resulting volatility is not merely inconvenient for traders — it creates genuine uncertainty for businesses and households trying to plan investment, borrow money, or fix mortgage rates. A rate environment that shifts 30 basis points in a single session based on a social media post from the Oval Office is not a rate environment that supports the kind of medium-term decision-making that underpins economic activity.
The ICE BofA MOVE Index, which measures implied volatility in Treasury markets, climbed sharply in March and has remained elevated — a proxy for the fact that, in a geopolitically-driven rate environment, the options market must price in a wider range of possible outcomes than it normally would.
The Ceasefire’s Partial Relief
The April 7 ceasefire reduced the volatility somewhat, but not in a way that restored anything resembling pre-war certainty. Citigroup, one of the more dovish Wall Street banks on rates, suggested that if oil prices continued to fall and inflation showed benign signs, up to three rate cuts starting in September were possible. But the baseline expectation across most major institutions remained far more cautious: at most one cut in 2026, with the timing deeply dependent on whether the ceasefire holds and the Strait of Hormuz reopens to normal traffic.
“A two-week pause is not a resolution,” as Yardeni Research’s Ed Yardeni summarised the situation. Financial markets will remain sensitive to any breakdown in talks. And in rate swap markets, “sensitive” has in the past two months meant: move by 20 or 30 basis points within a session, then reverse half of it the next morning.
That is not an environment in which anyone wants to hold a large directional rate bet. It is, however, the environment that the Iran war has created — and that central banks, investors, and everyone who carries debt are now required to navigate.
Written by Shalin Soni, CMA specializing in financial analysis, global markets, and corporate strategy, with hands-on experience in financial planning and analytical decision-making.
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Source: Based on Bloomberg and publicly available information.
Disclaimer
This article is based on publicly available information, market developments, and credible media reports. The content is intended for informational and analytical purposes only and should not be considered financial, investment, or legal advice.