Federal Reserve May Signal: Due to Iran War Impact, No Rate Cuts Expected This Year

How Will the Iran War Impact the Federal Reserve’s Interest Rate Decision Path?

Source: Global Market Report

The Federal Reserve’s two-day policy meeting will conclude on Wednesday, with a key question still unresolved: Will the Iran war, which has driven up oil prices and gasoline costs, lead the central bank to cut short-term interest rates again this year? Or will policymakers have to hold steady for months and wait to see how the conflict unfolds?

Fed Chair Jerome Powell is almost certain to announce on Wednesday that the central bank will keep the key interest rate around 3.6% for the second consecutive meeting. However, the Fed will also release its quarterly economic projections, which may lower expectations of a rate cut this year to zero. This seemingly minor adjustment actually marks a significant shift after 18 months of repeated rate cuts.

Regardless of the Fed’s decision, this is a difficult moment for policymakers to release economic forecasts. The Iran war launched by the Trump administration on February 28 has caused gasoline prices to surge, and inflation is expected to remain elevated for at least one or two more months. The inflation forecast released by the Fed on Wednesday will have to be higher than the December 2022 projection—when officials expected inflation to fall to 2.6% by year-end.

Many economists expect that even by 2026, the Fed’s inflation forecast could still be as high as 3%. Such a significant rise in inflation is difficult to reconcile with a policy path of further rate cuts.

Meanwhile, if gasoline prices continue to rise sharply and for an extended period, it could drag down the economy—consumers will spend more at gas stations, leaving less money for other goods and services. This could lead to higher unemployment later this year.

According to AAA data, the national average gasoline price on Tuesday was $3.79 per gallon, up 88 cents from a month ago.

The combination of rising inflation and increasing unemployment typically pushes the Fed’s policy in opposite directions. The central bank would raise or hold rates to curb inflation, while cutting rates would aim to stimulate spending and employment. The coexistence of rising prices and higher unemployment is generally considered the worst-case scenario for the Fed.

Additionally, this week’s meeting will be the second-to-last for Chair Powell. His term ends on May 15, and President Trump has nominated former senior Fed official Kevin Woeh to succeed him. However, Woeh’s nomination is blocked in the Senate due to opposition from key Republican senators over Justice Department investigations into Powell’s building renovations.

Last Friday, a judge dismissed two subpoenas issued by the Justice Department to the Fed, dealing a setback to the investigation. But U.S. Prosecutor Jenna Pirola said she will appeal.

Unless Woeh is confirmed by the Senate before May 15, Powell will continue to serve as Chair of the Federal Reserve’s rate-setting committee until a new chair is appointed. Otherwise, this week’s meeting will be his penultimate.

Even before the Iran war erupted, inflation and employment data already posed challenges for the Fed. The inflation indicators favored by the Fed showed that January’s price increases were faster than in recent months, with core inflation (excluding food and energy) at 3.1% year-over-year—almost unchanged from two years ago—indicating stubbornly high prices.

The labor market is also in trouble. Earlier this month, the government reported that in February, employers cut 92,000 jobs, an unexpectedly weak showing; in January, there was an increase of 130,000 jobs, which was encouraging. The unemployment rate rose slightly from 4.3% to 4.4%, remaining at a low level.