Federal Reserve Holds Steady! Middle East Situation Uncertain, Rate Cut Possible Once This Year, Powell Denies Stagflation

Question: How does the Middle East conflict influence the Federal Reserve’s interest rate decision balance?

On Thursday (the 19th) early morning Beijing time, the Federal Reserve announced its March interest rate decision. The Federal Open Market Committee (FOMC) decided to keep the interest rate range unchanged at 3.50%-3.75% with an 11-1 vote. The dissenting vote came from Fed Governor Milan, who proposed a 25 basis point cut.

The Fed’s quarterly economic outlook (SEP) slightly raised its economic and inflation forecasts. The employment market remains generally stable. The closely watched dot plot predicts one rate cut this year, consistent with December last year. Fed Chair Jerome Powell stated that due to the high uncertainty caused by the Middle East war, the Fed will make rate decisions at each meeting. If the Fed Chair nomination is not confirmed by the end of the term, an interim acting chair will serve.

Economic impact remains to be seen

The Fed’s statement indicates that recent economic activity has been expanding at a steady pace. Employment growth remains modest, with little change in unemployment rates over the past few months, though inflation remains relatively high.

Notably, the statement added remarks on geopolitical factors: the development of the Middle East situation’s impact on the U.S. economy remains uncertain.

Fed Chair Powell said at the press conference that, influenced by Iran conflicts, soaring oil prices are expected to temporarily boost inflation. “Short-term inflation expectations have risen in recent weeks, possibly reflecting oil price surges caused by Middle Eastern supply disruptions. But it is too early to judge the scope and duration of their potential economic impact.” He added that monetary policy is well-prepared and will decide on further adjustments based on the latest data, evolving economic outlook, and risk balance.

The latest economic projections (SEP) show the Fed raising its GDP growth forecast for this year by 0.1 percentage points to 2.4%. The 2027 growth forecast was revised up by 0.3 percentage points to 2.3%, and 2028 by 0.2 percentage points to 2.1%.

Inflation remains stubborn. The Fed expects core PCE inflation to be 2.7% this year, up 0.2 percentage points from December, and revised up 0.1 percentage points to 2.2% for 2027. Overall PCE inflation was also revised upward by 0.3 percentage points to 2.7% this year, and by 0.1 percentage points to 2.2% in 2027.

Powell noted that the pace of inflation slowdown cannot meet the Fed’s desired levels. “Starting mid-year, we expect to see changes in tariffs… Once the related impacts are fully reflected, the inflation pressure from tariffs will subside.”

The employment market remains resilient. The Fed projects this year’s unemployment rate at 4.4%, unchanged from previous forecasts, with a revision up of 0.1 percentage points to 4.3% in 2027, and the long-term unemployment rate at 4.2%.

Regarding these forecasts, Powell said, “No one knows” what impact the conflict will have. “The net effect of oil price shocks will continue to exert downward pressure on spending and employment, while exerting upward pressure on inflation.” However, he added that these shocks can be offset by higher domestic energy production.

He then dismissed concerns about stagflation, stating that the term would only be used if the economic situation were much worse.

Interest rate path remains uncertain

The FOMC’s interest rate outlook remains unchanged. The median rate for 2026 is 3.4%, implying one rate cut. For 2027 and 2028, the median rates are 3.1%, corresponding to a range of 3.00%-3.25%.

The updated dot plot shows significant disagreement within the Fed. Of the 19 participants, 7 expect either no change or a rate cut this year. It is also predicted that one member, possibly Milan, advocates for a bold 100 basis point cut in 2026. For 2027 and 2028, the most favored ranges are 3.00%-3.25%, with 6 and 7 members supporting these, respectively, but overall opinions remain divided, similar to December last year.

Regarding the interest rate outlook, Powell believes the Fed must balance labor market conditions and inflation risks, making rate cut decisions difficult. “We are balancing two major objectives: the current labor market faces downside risks, which support rate cuts; while inflation faces upside risks, which support rate hikes or no change.” He added, “This puts us in a challenging position. Our policy framework requires us to balance these risks. The current rate level is in a restrictive to neutral zone, leaning towards the tight side.”

Powell reaffirmed that monetary policy will not follow a fixed path. “Policy is not on a preset trajectory; we will make decisions at each meeting.” He emphasized that the Fed’s dual mandate is full employment and price stability. “We remain committed to supporting full employment and bringing inflation back to 2%, anchoring long-term inflation expectations.”

Although the dot plot suggests a possible rate cut this year, Powell acknowledged that if inflation remains stubborn, this outlook could change. He said, “Rate forecasts are conditional, depending on economic performance. So if we see no progress on inflation, we won’t cut rates.”

Despite pressure from the Trump administration, Powell emphasized the Fed’s independence, which allows it to fulfill its responsibilities. Its independence has broad support from both Democrats and Republicans in Congress.

Regarding his own future, Powell said he has no intention of leaving the Fed Board before the end of the Department of Justice investigation. Notably, the confirmation process for the new Fed Chair nominee, Kevin Woeh, has been delayed. He stated, “If the Fed Chair is not confirmed by the end of my term, I will serve as interim acting Chair.”

Policy outlook

The focus of this Fed meeting was on assessing the impact of the energy price surge caused by the conflict on inflation and economic output, with continued uncertainty. The conflict has paralyzed shipping through the Strait of Hormuz, which carries about one-fifth of global oil and LNG supplies. Rising oil prices will dampen economic prospects by increasing gasoline prices and weakening consumer spending.

Due to the Iran conflict, Brent crude futures briefly surged past $109 per barrel on Wednesday. U.S. February Producer Price Index (PPI) data also showed strength, leading futures markets to significantly lower expectations for rate cuts this year. According to the CME Group’s FedWatch tool, there is little chance of a rate cut before December.

U.S. stocks fell sharply during the session. Michael Arone, Chief Investment Strategist at State Street Global Advisors, said that short-term oil price movements will serve as an “effective barometer for risk asset performance.” He noted that breaking $100 per barrel would be a psychological threshold, “which could further shock the markets.”

Inflation swaps, a future indicator of consumer price expectations, are quietly rising. Last week, the 1-year inflation expectation soared to nearly 3%, the highest in about five months, well above the 2.4% year-over-year figure from February.

Latest data from the New York Fed released Monday shows that, as of February, U.S. consumer credit applications reached their highest level in nearly four years. Most of the demand was for higher credit card limits rather than new loans of other types. The survey indicates that while credit demand is rising, approval difficulty has decreased. The rejection rate for new credit was 15.9%, the lowest since June 2021.

Wall Street remains concerned about economic growth and the “tipping point”—a classic “stagflation” dilemma that is hardest for central banks to predict and communicate. “As the conflict persists, oil prices remain high and volatile, the economic outlook darkens,” wrote Societe Generale’s chief economist Subadra Rajappa. “Although our baseline scenario assumes the conflict will be resolved promptly without lasting economic impact… high inflation and worsening labor market conditions make it difficult for the Fed to balance its dual mandates (full employment and price stability).”

“Just as the worst phase of policy confusion seems to be ending, we face the Iran war again,” reflected Dario Perkins, Chief Global Macro Strategist at TS Lombard, recalling the series of shocks from the pandemic, inflation, rapid Fed rate hikes, and policy shifts after Trump’s return to the White House. “Our baseline assumption is that the conflict will be short-lived, and ‘this too shall pass.’ But… will this energy crisis be the last straw that breaks the economy?”