How many rate cuts? Iran war upends Federal Reserve’s next steps

The Iran war has thrown the Federal Reserve’s economic calculations into disarray, likely delaying anticipated interest rate cuts and prolonging financial strain for American consumers facing high borrowing costs. As Fed officials conclude their crucial meeting Wednesday, they confront a challenging economic puzzle that has no easy solution.

The conflict has triggered a spike in oil and gas prices, creating a classic economic dilemma for the central bank. Traditionally, rising energy prices push inflation higher—a scenario that would normally prompt the Fed to maintain or even increase interest rates. However, sustained high energy costs could simultaneously damage economic growth and increase unemployment, which typically calls for the opposite approach—cutting rates to stimulate the economy.

Given these conflicting pressures, analysts widely expect the Fed to maintain current rates as officials assess the war’s economic impact. Many economists now predict the first rate reduction won’t come until September or later, a significant shift from earlier expectations.

“With Iran and the oil shock, I think the committee’s room for maneuver here is pretty limited,” said Nathan Sheets, chief global economist at Citi and a former senior Fed economist. “I think they’ve got to wait and see how this plays through.”

Complicating matters further, the Fed must release its quarterly economic projections following Wednesday’s meeting. In December, officials forecast inflation cooling to 2.6% by year-end, with core inflation (excluding food and energy) falling to 2.5%. However, those figures were already rising before the conflict, with January’s core prices increasing 3.1% year-over-year—the largest jump in more than two years.

The Fed had previously projected one rate cut this year, a forecast that now appears increasingly unrealistic if inflation projections rise. The central bank cut rates three times last year before pausing in January.

Tim Duy, chief economist at SGH Macro, argues the Fed should raise its forecast for core inflation to at least 2.8% by year-end, a level that would make rate cuts unlikely in 2023. “Any reasonable forecast for inflation now should not have a cut,” Duy said. “And it’s almost ludicrous that it might.”

Whether the Fed maintains its forecast of a single rate cut this year remains uncertain. Several influential Fed members—including governors Chris Waller, Stephen Miran, Michelle Bowman, and possibly Chair Jerome Powell—appear reluctant to abandon the prospect of reducing rates. Waller recently suggested in a television interview that inflation is still trending toward the Fed’s 2% target, with the war likely representing only a temporary disruption.

Meanwhile, another contingent of Fed officials—including Beth Hammack, president of the Cleveland Fed, and Austan Goolsbee, Chicago Fed president—were already concerned about persistent inflation before the conflict. Higher gas prices will likely intensify these worries.

The uncertainty has already affected consumers. Mortgage rates climbed to 6.1% last week from 6%, as markets anticipate inflation will remain elevated. While still below last year’s 6.7%, the increase adds financial pressure on potential homebuyers.

The Fed also faces a significant leadership transition, with Powell’s term as chair ending May 15. President Donald Trump has nominated former Fed official Kevin Warsh as his replacement, but the nomination has stalled in the Senate amid a Justice Department investigation concerning Powell’s testimony about a building renovation. A judge recently dismissed subpoenas related to the investigation, though U.S. Attorney Jeannine Pirro plans to appeal.

Adding to these complications is the lingering trauma from the pandemic-era inflation surge. Typically, the Fed might look past a temporary supply shock like Middle East oil disruptions, knowing inflation would naturally subside once the crisis ends. However, when COVID-19 restrictions eased in 2021, inflation soared as Americans increased spending, fueled by stimulus checks and pandemic savings.

Powell initially described this inflation as “transitory,” predicting it would fade as the economy normalized. Instead, it reached a four-decade high in June 2022—a miscalculation that has made Fed officials wary of downplaying inflation risks again.

“I think they are a little scarred from the blowback they got from the word ‘transitory,'” noted Derek Tang, an economist at consulting firm Macro Policy Analytics.

This institutional caution, combined with fresh geopolitical uncertainties, suggests Americans may wait considerably longer for relief from high interest rates than previously anticipated.