The US Federal Reserve was already managing a delicate balancing act. The Iran war is making it even more difficult.
Policymakers at the world's most significant central bank had been expected to hold interest rates steady in the range of 3.50 and 3.75 per cent this week, but the broadening conflict in the Middle East now complicates a dual mandate that is already in tension.
“It's really adding insult to injury when it comes to the inflationary side of things,” said Derek Tang, an economist at MPA Macro.
US Fed officials were expected to maintain their wait-and-see posture following three rate cuts last year after progress in taming inflation had stalled.
Government data showed the Fed's preferred inflation metric remained stubbornly high in January, rising 0.3 per cent on a monthly basis and 2.8 per cent year-on-year. Core inflation, which strips out food and energy prices, rose 3.1 per cent annually.
Disruptions in the Strait of Hormuz and Iranian attacks on key energy sites across the Gulf region have upended energy markets, where oil prices climbed as high as $120 a barrel last week. Emergency measures from the International Energy Agency and US to release stockpiles have had a negligible effect on oil prices.
As of Friday Brent crude was hovering around $100 a barrel, while US crude was trading at approximately $95 a barrel. Iran has threatened a prolonged conflict that would see prices spike to $200 a barrel, which Washington has pushed back on.
The Fed typically looks through volatility in oil prices, which tend to be more turbulent than other pressure points. However the scars of a post-Covid inflationary surge linger, and inflation has remained above the US central bank's 2 per cent goal for five years.
economist at MPA Macro
“The space the Fed has to look through a shock like this is smaller now for the March meeting,” Mr Tang said.
Bernard Yaros, lead US economist at Oxford Economics, said the supply shock this time around is different to the one the global economy faced following Russia's invasion of Ukraine in 2022.
Oil prices had also spiked during that episode, but the US labour market was on a post-Covid hiring spree and two rounds of fiscal stimulus led to an overheating of the US economy.
“They're fairly scarred from that period, but I think they'll also acknowledge that this time is much different,” Mr Yaros said.
That means the Iran conflict also poses a challenge for the other side of the Fed's dual mandate: maximum employment.
Employment figures have been mixed in recent months, with a better-than-expected January jobs report offset by a “train-wreck” February report, a Wells Fargo team of economists led by Tim Quinlan wrote.
Nonfarm payrolls fell by 92,000 last month (compared to expectations of 50,000), sharply below the downwardly revised 126,000 gains in January. The unemployment rate edged higher to 4.4 per cent.
Rising oil prices lead to higher prices elsewhere, notably at petrol stations where the average price per gallon has risen to $3.63 from $2.94 a month ago, according to automotive group AAA.
A sustained increase could force consumers and businesses to contract spending in other areas such as investment or construction.
“Growth will be slower, and if that really seeps into the labour market, the labour market weakens, and we're already in a very fragile equilibrium in the labour market with low hire, no fires, but also no hiring,” Mr Yaros said.
Negative growth effects could lead the Fed to intervene by cutting interest rates. However traders appear to be more concerned by upside risks to inflation.
CME Group data showed that markets anticipate just one cut this year – in December – following previous expectations of two 25-basis point reductions.
Fed officials have delivered contrasting views on their future rate-cut paths, and traders will be closely monitoring the central bank's latest update on where they believe rates will fall in the coming years.
Projections released by the Fed in March showed officials expect the federal funds rate to fall to roughly 3.4 per cent by the end of this year, before easing slightly further to 3.1 per cent by end of 2027.
A more hawkish or dovish posture by Fed Chair Jerome Powell during his post-meeting news conference will also be closely monitored by Wall Street, where US equities have whipsawed since the Iran conflict began on February 28.
The S&P 500 was on track for its third consecutive losing week on Friday as traders weighed geopolitical risks. The Dow Jones Industrial Average has lost more than 2,000 points since the conflict began, while the Nasdaq Composite has declined 2 per cent in the same period.
“There are significant spillovers that could still occur, and this would not only curtail spending, but it would reduce liquidity in the overall market, reducing tightening credit conditions and really putting the brakes significantly on the US and global economy,” Constance Hunter, chief economist at Economist Intelligence, said during a webinar.
