Iran war is making it harder for the Federal Reserve to cut interest rates
Americans eager for lower borrowing costs may have a long wait ahead of them.
The Iran war is complicating the picture for the Federal Reserve, which is set to meet on March 18 for its next interest rate decision. Economists had predicted the Fed would hold its benchmark rate steady on Wednesday, but many had penciled in a cut at the central bank's next meeting in June.
Soaring oil and gas prices, sparked by the conflict in the Middle East, now have economists tearing up their forecasts. Higher energy prices could ripple through the economy, pushing up transportation costs, food prices and utilities, according to Wall Street analysts.
The specter of higher inflation poses a conundrum for policymakers, who face the challenge of ratcheting down inflation toward the Fed's 2% annual target while also propping up a labor market that is showing signs of fatigue.
On March 13, the Fed's preferred inflation gauge — the Personal Consumption Expenditures index — showed that consumer prices crept higher in January, a sign that costs continued to rise even before the Iran war's impact on the energy sector.
What to expect on Wednesday
There's a 99% probability that the Fed will hold its benchmark rate steady in a range of 3.5% to 3.75% on March 18, according to CME FedWatch, which bases its forecast on 30-Day Fed funds futures prices.
There's now a 95% probability the Fed maintains the current range at its April 30 meeting and a 77% likelihood that it will hold steady in June, CME FedWatch says. A month ago, those probabilities stood at 70% and 31%, respectively.
No cuts in 2026 — or even a hike?
Rising energy prices since the outbreak of the Iran war have led a number of forecasters to rewrite their interest rate predictions, with some economists saying there's a chance the Fed won't make cuts this year.
"Given our higher headline and core PCE inflation forecast, we have revised our baseline to show only one 0.25-percentage-point rate cut in 2026, likely in December, but it is entirely plausible that the Fed won't deliver any rate cuts this year," EY-Parthenon chief economist Gregory Daco told investors in a report.
A few analysts even think the Fed could boost interest rates in 2026 to counter rising prices.
Rate hikes are the Fed's most potent weapon against spiraling inflation. That's because higher borrowing costs tamp down economic activity by making it more expensive for businesses and consumers to take out loans.
"An already large headache for the Federal Reserve is going to turn into an even larger one, and it's likely the Fed will not cut rates in 2026 and may even start talking about rate hikes later this year," said Sonu Varghese, chief macro strategist at financial advisory firm Carson Group, in an email.
Mortgage rates on the rise
In the meantime, mortgage rates have crept higher since the start of the Iran war.
The benchmark 30-year fixed-rate mortgage rate had dropped below 6% in late February, marking its lowest level since Sept. 8, 2022. But that had jumped to 6.26% as of March 16, according to data from the Mortgage Bankers Association.
"Mortgage rates are based on bonds, and bonds spent last week bracing for the impact of higher energy prices. In the bond world, higher inflation begets higher rates, all else equal," the Mortgage Bankers Association noted in a Monday analysis.
Jobs flashing yellow
The Fed is also grappling with weaker hiring across the U.S., with employers shedding 92,000 jobs in February. That marked an unexpected downturn for the labor market as economists had expected an increase in job growth last month.
"The job market has softened over the past few years, and inflation is running higher than the Fed would like and will pick up even more in the near term," PNC economist Gus Faucher told clients in a research note.
He added, "This could create a dilemma for the central bank — cut the fed funds rate to support the labor market and inflation could move even higher, or keep the fed funds rate where it is and risk further weakness in the labor market."
These crosscurrents could also complicate life for the next Fed chief. President Trump in January nominated former Fed official Kevin Warsh to succeed Jerome Powell as the central bank chair. Powell, who Mr. Trump has repeatedly admonished for what he sees as the Fed's excessive caution in bringing down interest rates, is set to step down from his role in May.
But Warsh, who must still be confirmed by the Senate, could end up stepping in to lead the Fed amid mounting inflationary pressures, complicating his job.
"If and when Kevin Warsh is confirmed as Fed chair, he will first need to demonstrate that his policy views are grounded in economic fundamentals rather than political considerations," EY-Parthenon's Daco said.
