The Projected Federal Reserve Script Has Been Flipped -- and the Stock Market Isn't Ready for It

For years, the Dow Jones Industrial Average (DJINDICES: ^DJI), S&P 500 (SNPINDEX: ^GSPC), and Nasdaq Composite (NASDAQINDEX: ^IXIC) have appeared unstoppable. The evolution of artificial intelligence (AI), record corporate share buybacks, and the prospect of lower interest rates have fueled this bull market rally.

But the foundation for one of Wall Street's key pillars is crumbling, and neither Wall Street nor everyday investors are ready for it.

Image source: Getty Images.

Say goodbye to the Federal Reserve's rate-easing cycle?

With the stock market entering 2026 at its second-priciest valuation since 1871, according to the S&P 500's Shiller Price-to-Earnings (P/E) Ratio, investors have been counting on additional interest rate cuts by the Federal Reserve to fuel growth. Reducing lending rates can encourage businesses to borrow, ultimately leading to increases in hiring, innovation, and acquisitions. Lowering interest rates is similar to pressing the accelerator in a car to make it go faster.

But the Iran war has thrown a monkey wrench into the central bank's plans.

Since the U.S. and Israel launched military attacks against Iran on Feb. 28, oil prices have soared. This is in direct response to Iran's virtual closure of the Strait of Hormuz, through which approximately 20% of the world's liquid petroleum travels daily. This oil price shock is expected to resonate throughout the U.S. economy and notably raise the inflation rate in the months to come.

The odds of a rate hike over the next three months is now higher than the odds of a cut. A month ago, no one would have believed this. pic.twitter.com/a9K0cTXJS1

-- Ryan Detrick, CMT (@RyanDetrick) March 17, 2026

According to estimates from the Federal Reserve Bank of Atlanta, courtesy of Carson Group's Chief Market Strategist, Ryan Detrick, there's now a higher probability of the Fed hiking rates over the next three months than there is of the central bank cutting rates.

Just as lowering borrowing costs is designed to accelerate economic growth, raising interest rates often cools lending demand and tempers growth expectations. It wouldn't be particularly good news for the AI-driven technology sector.

If the Fed's script flips, Wall Street's bull market rally may be over

While higher interest rates can make borrowing costlier for consumers and businesses, they can also be devastating for the stock market.

The S&P 500's Shiller P/E, also known as the Cyclically Adjusted P/E Ratio (CAPE Ratio), has averaged 17.35 over the last 155 years. Over the last five months, it's been vacillating between 39 and 41. History has made clear that extended valuation premiums aren't sustainable over the long term.

S&P 500 Shiller PE Ratio hits 2nd highest level in history 🚨 The highest was the Dot Com Bubble 🤯 pic.twitter.com/Lx634H7xKa

-- Barchart (@Barchart) December 28, 2025

The CAPE Ratio has exceeded 30 on six occasions since 1871, including the present. Following the five previous instances, the Dow Jones Industrial Average, S&P 500, and/or Nasdaq Composite fell by at least 20% each time. After the Shiller P/E peaked at 44.19 in December 1999, the S&P 500 and Nasdaq shed 49% and 78% of their respective value.

If the Fed's script flips from rate-easing to rate-hiking, arguably, the bedrock of this historically expensive stock market will be fractured beyond repair. Even removing the possibility of rate cuts from the table may be enough to take the wind out of Wall Street's sails.

While more than a century of data shows that stocks offer the highest long-term annualized returns of all asset classes, the table appears set for a bumpy ride on Wall Street over the next few quarters.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.