Iran war muddles expectations of likely Federal Reserve interest rate cuts
Unlock the Editor’s Digest for free Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter. Investors have trimmed bets on the number of interest rate cuts this year as surging petrol prices and a softening jobs market complicate the Federal Reserve’s ability to boost the US economy while containing inflation….
Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Investors have trimmed bets on the number of interest rate cuts this year as surging petrol prices and a softening jobs market complicate the Federal Reserve’s ability to boost the US economy while containing inflation.
Many had predicted the Fed would make two cuts ahead of crucial midterm elections in November when US voters will pass judgment on whether the president has addressed what many perceive to be a cost-of-living crisis.
But bets on Fed cuts have fallen this week.
Traders in the futures market now see the US central bank only lowering interest rates once or twice this year, with the first cut not coming until September. Last week, that same market had priced in two or three cuts starting in July.
The cost of a barrel of West Texas Intermediate, the US benchmark, has risen 36 per cent to $90.90 since the US and Israel attacked Iran last weekend —the biggest weekly rise since 1983. Prices at petrol pumps, one of the most visible forms of inflation, are up more than 30 cents to $3.32, the highest level since the summer of 2024.
On Friday, recent signs of a stabilisation in the US labour market were undone after the Bureau of Labor Statistics said the world’s largest economy shed 92,000 jobs in February.
Joe Brusuelas, chief economist at RSM US, warned of the “risk of stagflation” — a situation in which growth slows and prices rise at the same time.
“All eyes will continue to be focused on the direction of energy prices and inflation,” Brusuelas said. The Fed’s capacity to respond to recent economic shocks creates “a real stress test” for rate-setters if oil prices remain high and Trump’s trade and immigration policies continue to stop companies hiring more workers, he added.
Markets on Friday were more worried about a prolonged rise in prices than the health of the jobs market. Goldman Sachs warned the price of global benchmark Brent crude would exceed its 2008 peak of $140 per barrel should the Strait of Hormuz remain closed.
The 10-year US Treasury yield rose 0.18 percentage points, its worst week since Donald Trump’s “liberation day” tariffs announcement last April.
The US president has called on the central bank to cut short-term borrowing costs from their current level of 3.5 per cent to 3.75 per cent to levels as low as 1 per cent.
The Federal Open Market Committee meets in mid-March, when investors expect the Fed will hold rates steady. The FOMC will also release new so-called “dot-plot” projections, in which officials lay out how many times they think they would probably cut borrowing costs over the coming year and beyond, following the vote.
The combination of a soft labour market report and higher oil prices could widen existing divisions within the committee on whether to prioritise prices or jobs.
Fed governor and FOMC dove Michelle Bowman told Bloomberg the weak jobs report confirmed the labour market “could use some support”.
Other doves, such as Mary Daly, the president of the San Francisco Fed, were more measured.
“No one is looking at any one dataset or relying on one anecdote,” Daly said at the University of Chicago Booth US Monetary Policy Forum in New York. She does not hold a vote on the FOMC but is a member.
Some rate-setters viewed figures out earlier this week from payroll support company ADP as positive.
For now, officials will look through the oil price shock which,given the US’s status as a net energy exporter, is unlikely to have the same impact as in Europe.
Christopher Waller, a Fed governor who is one of the more dovish members of the FOMC, told Bloomberg Television on Friday: “You’re going to see a spike in gasoline prices, that’s what the American citizens are going to see at the pump, and they’re going to stare at it and be a little shocked . . . but, for us, thinking about policy going forward, it’s unlikely to cause sustained inflation.”
But some note that with inflation above the Fed’s 2 per cent goal for five years, the central bank could be forced to confront the impact of the Iran conflict.
“We are one of the few economies still dealing with post-pandemic inflation,” Diane Swonk, chief economist at KPMG US. “Recent data shows it is accelerating again and that there is more in terms of tariff hikes in the pipeline.”
