The Federal Reserve Under Middle East Conflict: Powell's 2% Inflation Target May Not Hold

Questioning AI · How Middle East War Fires Push Up U.S. Federal Reserve Inflation Expectations?

Text | Zhou Ailin

Editor | Liu Peng

Since the outbreak of the Iran war, the average price per gallon of gasoline in the U.S. has risen by nearly $1, a 30% increase in Americans’ fuel costs.

Commuters driving from New Jersey into New York City have long seen gas prices rise at stations. In mid-February, gasoline was about $2.90 per gallon. By mid-March, it had climbed to $3.70 per gallon.

Amid this anxious atmosphere, the Federal Reserve, which already has tense relations with President Trump, held its March policy meeting. Just before the meeting, oil prices surged on threats of Iranian retaliation. The Fed kept the federal funds rate unchanged at 3.5%–3.75%, but raised its forecast for core PCE inflation by 0.2 percentage points to 2.7%, and expects only one rate cut in 2026 and 2027. Wall Street has delayed this year’s rate cut to September.

“Trump says oil prices will soon fall. What do you think?” a U.S. reporter asked Fed Chair Powell. He appeared somewhat evasive and quickly responded, “I have no forecast,” “I prefer not to speculate about the future,” “No one has a crystal ball.” He did not mention Trump by name.

Full video of Powell’s speech: maintaining rates, no plans to leave the Fed

“If I am still in office when a new Chair is not confirmed, I will serve as acting Chair. I will not leave the Federal Reserve until the Department of Justice investigation is complete.” The U.S. economy was doing well, with inflation gradually approaching 2%. Now, Middle East conflicts have cast uncertainty, and Powell, whose term ends in May, may feel conflicted.

Delayed Rate Cuts, Higher Inflation Expectations

On the eve of the meeting, Iran’s massive South Pars gas field was attacked on Wednesday local time — the first strike on Iranian energy infrastructure in the Gulf region during the U.S.-Israel conflict, marking a significant escalation. Iran warned neighboring countries to evacuate energy facilities. South Pars is one of the world’s largest gas fields, shared by Iran and Qatar across the Gulf.

Soon after, Iran’s Islamic Revolutionary Guard Corps issued an emergency warning, stating that Saudi Arabia, the UAE, and Qatar’s oil facilities could be legitimate targets, and attacks could occur within hours, urging residents to evacuate. However, retaliation has not yet occurred.

Amid rising oil prices, the Fed announced its rate decision. While holding steady was expected, the inflation forecast was raised more than some anticipated. The accompanying monetary policy statement updated the FOMC’s unemployment rate outlook, noting it has “changed little in recent months,” and hinted that developments in the Middle East could bring “uncertainty” to the economy.

Changes in the Fed’s Statement Language

The Fed released quarterly economic projections, with the biggest change being the lack of progress toward its 2% inflation target. The median forecast among FOMC members now expects PCE inflation to reach 2.7% this year (up from 2.4% in December), and the 2027 PCE forecast was slightly raised to 2.2% (from 2.1%).

The Fed also slightly raised its real GDP growth forecast to 2.4%, while keeping this year’s unemployment rate forecast unchanged at 4.4%, and nudged the 2024 forecast down to 4.3%.

Inflation, Employment, and GDP Forecast Changes

It appears that absent the surge in oil prices caused by Middle East tensions, the Fed’s dual goals of maximum employment and price stability could be achievable. Even with a sharp slowdown in layoffs, the overall unemployment rate remains around 4%, and GDP growth exceeds 2%.

Regarding the much-watched “dot plot” for interest rate projections, even the most dovish members have returned to consensus — the forecast near 2% from December has disappeared, and the previous range of 2.5%-2.75% has been raised to about 3%-3.125% (each dot representing a voting member’s view). Overall, the forecast range has narrowed, indicating the committee is leaning toward a more gradual, smaller-scale rate cut path.

Dot Plot

Goldman Sachs recently pushed back its rate cut predictions to September and December, and raised its 2026 PCE inflation forecast by 0.8 percentage points to 2.9%.

The Nearing End of Powell’s Term Seems Frustrating

Faced with the sudden war, Powell, nearing the end of his term, seems somewhat resigned.

The current situation is reminiscent of the 1970s oil crisis. Powell told reporters he does not want to describe the current environment as “stagflation.”

“In the 1970s, unemployment was in double digits, and inflation was extremely high, but that’s not the case now. I don’t want to use the word ‘stagflation,’” he said. He also admitted, “The current situation is that we are trying to balance two conflicting goals, but this is not stagflation.”

When asked how he would decide if oil prices stay above $100 until the next meeting, or whether rates would be kept unchanged indefinitely, Powell dodged, saying, “We have a lot of new information to observe, including how the Middle East conflict affects inflation prospects. It’s too early to say, and we don’t know yet.”

“Gasoline costs have risen by $1 per gallon. I hope this doesn’t last long,” Powell said. “People will feel the impact of higher oil prices, but I prefer not to speculate about the future.”

Market reactions to Powell’s comments included an 8 basis point rise in the 2-year U.S. Treasury yield, approaching a 7-month high; the dollar index (DXY) also rebounded, aiming to return near 100.

“Looking ahead, the key level to watch is 100.50, the recent high. Breaking above that could open the door to a move above 101,” said Matt Weller, Global Head of Research at Gain Capital, in an interview with Tencent News “Qianwang.”

Oil Prices Dominate Everything

In the foreseeable future, oil prices will be the primary driver of market sentiment. The outlook is not optimistic. Under Israeli Defense Forces’ relentless bombing, Iran’s Revolutionary Guard has not backed down and has threatened retaliation.

According to Tencent News “Qianwang,” during the just-concluded Bloomberg New Energy Finance Beijing Summit, several domestic and international oil and gas experts expressed concerns about a potential Strait of Hormuz blockade. About one-third of global oil maritime trade passes through this strait. Estimates suggest that, after excluding rerouted shipments through the Red Sea or Oman Gulf, actual affected oil supply could exceed 10 million barrels per day.

Notably, before the conflict, global oil supply was already oversupplied — the 2026 forecast showed a surplus of over 3.17 million barrels per day, the highest in recent years. But the war has cut at least 6.7 million barrels per day of capacity. Whether the market shifts from surplus to tight depends on the conflict’s duration and intensity.

Although the U.S. is a net oil exporter, soaring prices will impact inflation. Many Asian countries are importers and face tougher challenges. While China, Russia, and IEA members hold strategic reserves, releasing these only temporarily stabilizes spot markets and cannot eliminate war premiums.

Experts believe that from China’s perspective, the current shock is manageable. Domestic oil production has exceeded 200 million tons for four consecutive years, reaching a record high of 216 million tons in 2025, with oil equivalent reserves replacing over a million tons annually for nine years. China’s strategic reserves are ample, and so far, only about 20 VLCCs have been affected. With relatively high commercial inventories and weak domestic demand, China can buffer at least a month of Qatar LNG shortages. Additionally, China has energy alternatives like coal chemical industry, coal-to-oil, and flexible trade adjustment capabilities, making its resilience stronger than the EU and Japan.

Regarding the current situation, “Oracle of Omaha” Warren Buffett once said, “The trick is to do nothing when there’s nothing to do.” For the coming months, it’s expected that Powell and the Fed will follow this advice, closely monitoring economic data and waiting for Iran’s conflict timeline to become clearer.