Fed sticks with plans to lower rates even as energy prices surge
The Federal Reserve has signalled a cut to interest rates this year even as the surge in oil prices triggered by the war in Iran threatens to ignite a fresh burst of inflation.
The rate-setting Federal Open Market Committee said on Wednesday after holding the benchmark federal funds target range at 3.5 to 3.75 per cent that “the implications of developments in the Middle East for the US economy are uncertain”.
In fresh economic projections, Fed officials signalled that they expected to make one quarter-point cut before the close of 2026 — in line with its previous quarterly projections in December. Twelve of the 19 members of the FOMC predicted at least one cut, against seven who said borrowing costs would end the year where they are now.
Fed chair Jay Powell said that while war in the Middle East would push up near-term inflation, it was “too soon to know the scope and duration” of the conflict’s economic impact.
“Near-term measures of inflation expectations have risen in recent weeks, likely reflecting the substantial rise in oil prices caused by the supply disruptions in the Middle East,” he told a press conference following the central bank’s decision.
Markets had sharply cut their expectations for rate cuts in the lead-up to Wednesday’s meeting, with federal funds futures showing traders pricing in no reduction in rates until mid-2027.
US government bonds traded in a tight range following the decision, with the yield on the two-year note up 0.03 percentage points at 3.7 per cent. Wall Street’s S&P 500 share index was at its low for the day, down 0.8 per cent.
Fed governor Stephen Miran was the sole dissenter from the decision to hold borrowing costs for the second meeting in a row, with the ally of President Donald Trump backing a quarter-point cut.
The decision to hold borrowing costs was widely expected even before US oil prices jumped almost 50 per cent after the US and Israel’s first attacks on Iran at the end of February, sending the costs of petrol and diesel at the pump zooming higher.
The Iran conflict has placed the Fed in a delicate balancing act over whether to prioritise its fight against price pressures over further signs of weakness in the US labour market.
The Bureau of Labor Statistics said the US lost 92,000 jobs last month, with several large companies announcing plans to lay off workers in recent weeks.
Headline personal consumption expenditures inflation remains above the Fed’s 2 per cent goal at 2.8 per cent. The central bank has not managed to hit its inflation target since 2021, raising concerns that the fresh wave of price pressures from higher oil prices will erode its credibility to keep price pressures under control.
The FOMC’s latest quarterly economic projections showed that officials now anticipate headline inflation at 2.7 per cent by the end of 2026 — against a December estimate of 2.4 per cent. Core PCE inflation, which excludes food and energy prices, would also end the year at 2.7 per cent, compared with the December estimate of 2.5 per cent.
Growth was set to come in slightly higher — at 2.4 per cent — compared with the December estimate of 2.3 per cent.
Tehran has largely closed the Strait of Hormuz, a waterway through which one-fifth of the world’s oil flows, in retaliation for the strikes on Iran, pushing up the price of US benchmark West Texas Intermediate to around $95 a barrel.
The disruption has caused a global supply crunch and is hitting US consumers and businesses despite the US’s role as a major energy producer. Petrol and diesel prices are now at their highest level in either of Trump’s terms in the White House.
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US stocks end at session low as dollar rallies
US stocks continued to slide following Jay Powell’s remarks, as the dollar rallied further and yields on Treasuries rose to their highest levels on the day.
Wall Street’s S&P 500 closed 1.4 per cent lower, with all 11 sectors falling and consumer staples the worst performers. Only 88 stocks ended the session in positive territory.
The dollar index — which tracks the currency against a basket of six international peers — rose 0.6 per cent.
The yield on rate-sensitive two-year Treasuries stood 0.1 percentage points higher on the day at 3.77 per cent, reflecting a decline in prices. It was their highest level since August.
“The Fed communicated that it is going to wait and see and that it has no inclination to act pre-emptively. The markets didn’t recoil in horror as a result but it was disappointed,” said Mike Zigmont at Visdom Investment Group.
Analysts react: No policy signal from ‘snoozefest’
Jay Powell’s remarks contained no real policy signal, according to analysts at TS Lombard, who described the Fed chair’s press conference as a “snoozefest”.
The lack of certainty over the impact of the Middle East war meant little could be extrapolated about future interest rate decisions, said Dario Perkins, TS Lombard managing director of global macro.
“Powell delivered the appropriate snoozefest, leaving interest rates on hold, making minimal adjustments to the [Federal Open Market Committee] statement, and merely updating the Fed projections to include the latest data, data that obviously precedes the war in the Middle East,” Perkins continued.
“[T]he Fed is evenly split on whether to cut rates again this year. But this is all very stale . . . Even Powell admitted that this particular dot plot was largely meaningless.”
Thomas Simons at Jefferies said that given the “wide range of outcomes” the Fed “appropriately decided” not to make assumptions about “completely unpredictable” geopolitical issues.
“This does little to change the near-term outlook for policy,” Simons said.