The geopolitical tensions in the Middle East, particularly the conflicts involving Iran, are causing turmoil in the global energy market, which could complicate the Federal Reserve's plans for interest rate cuts. The rise in energy prices is adding new upward pressure on inflation, significantly weakening market expectations for rate reductions.
Economists generally expect the Fed to maintain its policy interest rate at the March 18 meeting. However, many analysts had previously predicted the first rate cut would occur in June. The escalation of the situation in Iran has quickly driven up energy costs, forcing the market to reassess these predictions.
Wall Street analysts point out that rising energy costs could trigger price increases across multiple sectors, including transportation, food, and utilities. This places the Fed in a dilemma: on one hand, the central bank is committed to reducing inflation to its target level of 2%; on the other hand, it needs to support a labor market that is showing signs of weakness.
The Personal Consumption Expenditures (PCE) price index, released on March 13 and closely monitored by the Fed as a key inflation indicator, shows that prices continued to rise in January. Notably, this increase occurred before the Iranian conflict had a comprehensive impact on the energy market.
According to CME FedWatch data based on futures markets, there is a 99% probability that the Fed will maintain the interest rate at 3.5%–3.75% during the March 18 meeting. The same data indicates a 95% probability of keeping rates unchanged at the April 30 meeting, and a 77% probability for the June meeting. Compared to a month ago, these probabilities have changed significantly from 70% and 31%, respectively.
Given the rise in energy prices, some economists believe that the Fed may not cut rates at all this year. Gregory Daco, chief economist at EY-Parthenon, stated that due to rising inflation expectations, they have adjusted their baseline scenario and now anticipate only one 25 basis point rate cut in 2026, possibly in December. Daco added that the possibility of the Fed not cutting rates at all in 2026 cannot be completely ruled out.
Some analysts have more radical views, suggesting that to control inflation, the Fed might actually raise rates in 2026. Sonu Varghese, chief macro strategist at Carson Group, noted that the current situation poses challenges for the Fed, and if inflationary pressures increase further, the central bank may shift its discussions towards rate hikes rather than cuts later this year.
The weakness in the labor market is another issue facing the Fed. In February, U.S. companies laid off 92,000 workers, a development that surprised economists. PNC economist Gus Faucher pointed out that the labor market has been gradually weakening in recent years, while inflation levels remain above the Fed's ideal range.
Faucher believes the fundamental dilemma for the Fed is that it needs to cut rates to support the economy, but persistent inflationary pressures limit its room for action and may even force it to consider rate hikes to stabilize prices.