What Changed for Interest Rates in 2026?

 Editor's Note (June 23, 2026): This commentary has been updated to reflect market developments through June 23, including the ceasefire agreement between the United States and Iran and the subsequent reopening of the Strait of Hormuz. 

Fixed income markets, particularly interest rates, have been volatile in the first half of 2026, reacting and adapting from a positive setup coming into the year to a more uncertain and potentially negative outlook ahead. To understand where fixed income markets sit today, it helps to walk through where things stood at the beginning of the year, what caused the rapid change in markets and assumptions, and where that leaves us now.

A Constructive Start

The market entered 2026 on relatively solid footing. Corporate earnings remained strong, inflation had largely stabilized after a modest, tariff-driven uptick in late 2025, and the labor market appeared resilient despite some emerging signs of softness. Against this backdrop, investors broadly expected the Federal Reserve to continue easing monetary policy as inflation gradually moved closer to its long-term target.

That combination set the market up for falling interest rates, which is constructive on two fronts. It boosts fixed income performance, particularly for longer-duration securities, and it supports equity valuations, since lower rates lift the present value of future earnings. There were reasons for caution beneath the surface, including those labor-market cracks and questions about the sustainability of the elevated capital expenditures tied to AI and the hyperscalers, but most of the evidence pointed toward continued growth across markets.

The Shock

Then, on February 28, 2026, the picture started to change. The United States and Israel launched coordinated strikes on Iranian military, nuclear, and leadership targets, and the conflict widened across the region within days.

The economic consequence followed shortly after on March 2, 2026, when the Strait of Hormuz was effectively closed. The strait is the chokepoint through which roughly 20% to 25% of the world's oil supply moves, so its closure caused fuel shortages and a sharp increase in global oil prices. In the months since, the headlines have cycled through potential ceasefires, partial reopenings, renewed strikes, and further negotiation.

This matters far beyond the energy sector. Oil is a key input in nearly every part of the economy: transportation, manufacturing, raw input costs, and gasoline, just to name a few. A sustained upward move in the price of crude does not stay contained for long, and the uncertainty around how long the disruption will last is precisely what changed the interest rate outlook that had looked so positive in January.

Where We Stand Today

On June 17, 2026, the United States and Iran signed a memorandum of understanding that began a 60-day ceasefire, reopened the strait, and laid out a timeline for negotiations to formally end the conflict. As of today, the strait remains open, with vessels cautiously transiting the waterway, but there is certainly no guarantee this will hold throughout the full 60-day ceasefire.

This energy shock shifted expectations from disinflation and rate cuts toward concerns about rising inflation and rising rates. So far, the inflation data has shown a meaningful increase in energy inflation, while the remaining components have risen only modestly. This suggests that the broader economy is still digesting the higher oil prices and has not passed those costs on to the consumer just yet. The signing of the memorandum offered some near-term relief, with oil falling from around $100 per barrel to roughly $78, only modestly above where prices sat before the conflict. Whether that relief holds depends entirely on whether the strait remains open.

The concern from here is that the strait closes again, or oil otherwise stops flowing freely, causing the energy shock to spread to other industries and markets. If higher energy prices filter into transportation, manufacturing, wages, rents, and services, then inflation will broaden out beyond energy. The Federal Reserve would then be forced to raise interest rates in response. The market has increasingly come around to this view. Yields are higher across the curve, and the market is now pricing in roughly a 86% probability of rate hikes by year-end.

Going Forward

The shift has been  significant. In a matter of months, the picture flipped from a constructive backdrop of cooling inflation and expected rate cuts to an uncertain one defined by reaccelerating inflation, the prospect of rate hikes, and a sharp move higher in interest rates. The rosy setup that opened the year has given way to a far less certain outlook.

Against this backdrop, within fixed income we are looking to take advantage of higher interest rates by reinvesting the proceeds from maturing bonds at today's more attractive yields. At the same time, we are keeping duration short to limit our interest rate risk should rates continue to move higher. Staying short also allows us to reinvest at prevailing rates more frequently, compounding the benefit if yields stay elevated or rise further.

Within equities, we continue to focus on businesses trading at reasonable valuations that do not rely entirely on cash flows far out in the future. Because higher interest rates weigh most heavily on the present value of distant earnings, favoring companies with nearer-term, durable cash flows helps mitigate the negative impact rising rates have on equity valuations.