It’s easy to forget now, but one of the main bullish arguments for stocks heading into 2026 was the prospect of lower interest rates. The idea was simple. Lower interest rates stimulate the economy and effectively act as rocket fuel for stocks.
But as the year progressed, hopes for rate cuts were derailed, especially after the US invasion of Iran. Inflation has become an excessive concern. But stocks sustained a series of record highs, instead boosted by advances in AI that investors are scrambling to catch up to.
Now, in an ironic twist of fate, the direction of interest rates may pose the biggest threat to AI trading. It’s because of interest rate hikes A rate cut is now seen as much more likely to occur in 2026 than a rate cut. Goodbye rocket fuel.
So what has changed? Note two recent economic data points.
The combination of the two was enough to put rate hikes firmly back on the table. Investors are currently pricing in a 32% chance of this happening by the end of the year, up significantly from a week ago. At the Fed meeting in April 2027, the probability of a rate hike is actually higher than the probability of keeping rates unchanged. Meanwhile, the chance of a rate cut in 2026 has fallen to just 3%.
This change did not happen overnight. Let’s take a look at the 10-year bond yield since the start of the Iran war in late February. It rose 52 basis points to end Tuesday at a 10-month high. This shows investors have been bracing for weeks for a spike in inflation and the prospect of a more hawkish interest rate path.
The market move toward lower interest rates comes at a troubling time for incoming Federal Reserve Chairman Kevin Warsh. His appointment by Donald Trump initially led investors to believe that Warsh would go along with the president’s desire for multiple rate cuts. But now, with inflation heating up and yields following suit, his hands may be tied.
What this means for investors is that stock markets, and by extension AI trading, are facing new hurdles. The Nasdaq 100 certainly felt it on Tuesday, falling more than 2% at its intraday low.
After all, can productivity and profit growth from AI continue to offset rising inflation and monetary policy headwinds? Very possible. After all, all previous challengers have been dispatched. However, there is no denying that the path is becoming increasingly difficult.