Until a couple of weeks ago, Wall Street had convinced itself that the Fed\u2019s monetary policy path was heading downward: They expected the base interest rate to continue to \u201cnormalize\u201d from its pandemic highs, certainly notching lower than 3.5% to 3.75%, where it stands at today.<\/p>\n
Even before President Trump launched military action in Iran, that consensus was being challenged. Inflation is still stubbornly above its 2% target, and while the jobs sector is weak, it has not been alarming enough to spur significant action from the rate-setting Federal Open Market Committee (FOMC).<\/p>\n
With the chaos in the Middle East showing little signs of rapid de-escalation, the needle on whether the Fed will manage even a single cut this year has wavered. Some economists are now of the opinion that the next move by the FOMC will be a hike.<\/p>\n
The conflict in the Middle East has a significant impact on the Fed\u2019s mandate because it affects a range of factors for businesses and consumers alike. Most importantly, it increases oil prices because of disruption to supply from the region: Prices at gas station pumps are already rising above $4 a gallon, the most visible pass-through of rising barrel prices to the day-to-day consumer.<\/p>\n
Economists and analysts had generally hoped that the conflict would end in a matter of weeks. However, it seems the Oval Office may have bitten off more than it can chew: In the past few days alone, Israel launched strikes on Iranian oil fields, with Tehran launching attacks against Qatar as a result.<\/p>\n
Yesterday, Iran\u2019s foreign minister posted on X<\/a> that the attack employed a \u201cFRACTION of our power.\u201d Seyed Abbas Araghchi added: \u201cThe ONLY reason for restraint was respect for requested de-escalation. ZERO restraint if our infrastructures are struck again.\u201d One could argue there\u2019s little sign of tensions thawing anytime soon.<\/p>\n The inflationary pressure from the conflict may persist longer than expected, meaning the Fed may ultimately be restrained from confirming the further rate cuts the president has been so insistent on.<\/p>\n As Macquarie\u2019s David Doyle highlighted in a note to clients following Powell\u2019s press conference this week: \u201cStatement language changes were limited aside from an indication that the implications of the conflict in the Middle East are uncertain for the U.S. economy.\u201d<\/p>\n As such, \u201cWe see the next policy move as a hike with the most likely timing in 1H27.\u201d<\/p>\n While Doyle is on the more hawkish end of the Fed-watching spectrum, he\u2019s not alone in his estimations. EY-Parthenon chief economist Gregory Daco wrote on Wednesday that \u201cin light of upside risks to inflation and a hawkish \u2018once burned, twice cautious\u2019 stance among most Fed officials, our baseline features only one 25bp rate cut in 2026, likely in December.\u201d<\/p>\n That being said, \u201cit is entirely plausible that the Fed delivers no rate cuts this year, and there is a non-negligible chance that a rate\u00a0hike\u2014not a cut\u2014could be the next policy move.\u201d<\/p>\n The Warsh factor<\/p>\n Investors already seem inclined to agree. With more than a month until the next FOMC meeting, rate traders are already pricing in a more than 87% chance of a hold at the April meeting, according to CME\u2019s FedWatch barometer. <\/a><\/p>\n However, for the best part of the past year, the odds have been split between a hold and a cut\u2014but that\u2019s changed. At the time of writing, speculators had begun pricing in the possibility of a hike, estimating a 12.4% chance of an increase in the base rate of 25bps to 3.75% to 4%.<\/p>\n A factor that may shift those odds in meetings to come is the arrival of a new Fed chairman: Trump nominee Kevin Warsh. While the timeline of Warsh\u2019s progression through the approvals process currently has a question mark hanging over it, what markets do know is that anyone who comes in to lead the Fed will be more dovish on monetary policy than Jay Powell.<\/p>\n Trump has been clear, saying anyone he chose for the nomination would need to be open to cutting rates. Warsh could prove an ally to Governor Stephan Miran, a fellow Trump-nominee to the Fed who has continued to advocate for lower cuts.<\/p>\n Doyle\u2019s call of a hike in 2027 would likely come under the new leadership of Warsh, suggesting the incoming chairman may not be able to deliver the rapid cuts the White House is hoping for. Warsh\u2019s vote on the base rate is just one of many, but with a seat at the head of the table, his voice holds weight the markets will be watching closely.<\/p>\n