S&P 500 slips 1% as traders price out Fed rate cuts for 2026

The S&P 500 dropped approximately 1% on Thursday as traders reassessed whether the Federal Reserve will cut interest rates at all in 2026. The sell-off followed Wednesday's FOMC meeting, where the dot plot shifted to show a median of just one cut for the year and six of nineteen participants projecting zero cuts. Markets had been pricing in roughly two cuts before the meeting. That gap between expectation and reality is what drove Thursday's move.

The repricing was fast. Two-year Treasury yields, which are the most sensitive to near-term rate expectations, rose sharply to 3.86% on Thursday. That is a meaningful move for a single session. The two-year yield had been sitting near 3.65% earlier in the week before the Fed's updated projections landed.

Why the dot plot shift hit equities hard

Stock valuations are sensitive to interest rate expectations in a specific mechanical way. When investors discount future corporate earnings back to a present value, higher interest rates mean each future dollar of profit is worth less today. The S&P 500 is currently trading at approximately 20.5 times forward earnings estimates. At that multiple, even a modest upward shift in the rate path that investors assume can translate into a meaningful decline in fair value estimates.

Thursday's session saw the sharpest declines in rate-sensitive sectors. The real estate investment trust sector fell 2.1%, its worst single-day performance in six weeks. Utilities dropped 1.7%. Technology stocks were more resilient, with the Nasdaq Composite closing down 0.6%, partly because large-cap tech earnings expectations are less directly tied to borrowing costs than REITs or utility companies that carry heavy debt loads.

The Iran war's direct effect on the inflation picture

The energy shock from the Iran conflict is the specific mechanism pushing inflation projections higher and rate cut expectations lower. Brent crude at $118 per barrel adds directly to headline CPI through gasoline and diesel prices. The US Energy Information Administration estimated in March 2026 that every $10 increase in the price of crude oil adds approximately 0.3 percentage points to headline CPI over a three-month period, assuming the price increase is sustained.

The problem for the Fed is that oil above $110 for an extended period will keep showing up in monthly inflation readings even if core inflation, which strips out food and energy, stays contained. Markets care about the total picture because it shapes Fed communication and committee psychology, not just the technical metrics the Fed uses for its internal policy framework.

Global equities also pulled lower

The softness was not limited to US markets. Europe's Stoxx 600 closed down 0.8% on Thursday, with German industrial stocks and French energy companies among the larger decliners. Japan's Nikkei fell 1.1% in overnight trading as the yen strengthened slightly against the dollar following the Treasury yield move, which creates its own complications for Japanese exporters that benefit from a weaker currency.

Emerging market equities fared worse. The MSCI Emerging Markets index dropped 1.4% on the session, with oil-importing economies in Southeast Asia and South Asia seeing the largest declines. Countries like India, Thailand, and the Philippines import a substantial share of their energy needs, so sustained high oil prices directly compress their current account balances and put pressure on their currencies.

What the bond market is now pricing in

Fed funds futures contracts, which traders use to bet on where the Fed's policy rate will be at specific future dates, shifted materially after the FOMC meeting. As of Thursday's close, futures markets were pricing in approximately a 38% probability of even one rate cut by the end of 2026, down from roughly 72% before the Wednesday meeting. That is a significant repricing in less than 48 hours.

The 10-year Treasury yield, which had already risen to 4.52% on Wednesday after the dot plot release, held near that level through Thursday's session. Mortgage rates track the 10-year yield closely, and Freddie Mac's next weekly survey will almost certainly show the 30-year fixed rate moving above 7.2% if yields stay at these levels through the weekend.

What traders are watching next

The next major data point for markets is the March PCE inflation report, due April 11. If core PCE comes in above 2.6%, the already-slim probability of a first-half rate cut will effectively go to zero. The March jobs report, due April 4, will also matter. Nonfarm payrolls have been averaging 112,000 per month over the past three months. A reading below 100,000 would raise recession concerns alongside the inflation pressure, putting the Fed in a genuinely difficult position heading into the May 6-7 FOMC meeting.