Will the US-Iran conflict become the "interest rate cut dream" and a game-changer? The Fed's second-in-command once again pours cold water on the idea

On Thursday evening local time, Federal Reserve Vice Chair for Supervision Philip Jefferson stated that he expects the Iran-Israel conflict to push inflation higher in the short term, while monetary policy “is prepared to respond to a variety of economic outcomes.”

That day, in a speech in Dallas, he said, “At least in the short term, I anticipate that overall inflation will rise, reflecting the increase in energy prices due to the Middle East conflict.”

“Looking ahead, I believe the current policy stance enables us to better determine the magnitude and timing of further adjustments to the policy rate.” He added.

Jefferson is closely monitoring the situation in the Middle East and the global energy market, but he noted that it is still too early to judge what impact the economy will experience. He emphasized that the effects of the Middle East war largely depend on the duration of high energy prices: a brief disruption is unlikely to have a significant impact on the economy for more than a quarter or two, but sustained high oil prices could have major effects.

Coincidentally, Federal Reserve Governor Michael Barr also pointed out that the recent shocks, from surging oil prices to tariffs, have made it more complicated for the Fed to achieve its goal of reducing the inflation rate to 2%.

He also believes that if the conflict ends quickly, the impact on inflation and the economy may be limited; however, if the conflict persists, it could have broader implications for both. Barr is concerned that inflation has been above the Fed’s target level for five consecutive years and worries that if oil prices continue to soar, it could raise long-term inflation expectations.

“In light of the considerable uncertainty that developments in the Middle East may pose to our economy, as well as other factors I mentioned, it is reasonable to take some time to assess the situation. Our current policy stance puts us in a good position to maintain stability.” He added.

Inflation Impact

Jefferson also stated that so far, the impact of rising oil prices on inflation should be relatively small, although consumers are indeed seeing higher gasoline prices at the pump now. He is closely monitoring whether these higher costs will reflect in the price structure of the broader economy.

On the other hand, the longer energy prices remain high, the more households will need to weigh their trade-offs. Jefferson warned that families reliant on oil and gas for commuting, schooling, and heating may have to cut back on non-essential spending. This could lead to reduced spending at restaurants or retail stores, while also potentially increasing household debt levels.

He also noted that the ongoing uncertainty of tariff policies and the recent surge in energy prices have created a more complex economic environment for the Fed in addressing inflation and maintaining full employment.

Before the outbreak of the Iran conflict, the U.S. inflation rate had already been above the Fed’s 2% target for five consecutive years, and progress in reducing inflation seems to have stalled over the past year. Jefferson attributed this mainly to tariffs, but also pointed out that inflation in the services sector, excluding housing, has remained relatively stable over the past year. However, strong productivity growth and deregulation have somewhat offset this impact.

Job Market

Additionally, Jefferson stated that the job market is “broadly balanced,” but the risks are “tilted to the downside.” He noted that the unemployment rate is expected to remain around the current 4.4% this year, but overall job growth may still be low. He indicated that he will closely monitor the pace and composition of new job creation when assessing the health of the labor market.

However, he believes that the pace of economic expansion remains on par with, or slightly faster than, last year, while also noting that there is significant uncertainty in the outlook.

“There is a high degree of uncertainty in the current economic situation; rising energy prices and escalating conflicts in the Middle East have exacerbated this uncertainty. But I still believe that our current policy stance is appropriate and allows us to assess the direction of the economy,” he added.

(Source: Caixin)