The Federal Reserve’s decision on interest rates Wednesday is all but a foregone conclusion. Traders overwhelmingly expect it to keep rates on hold, a scenario that’s likely to persist for the rest of the year.
Instead, it’s how Chair Jerome Powell and policymakers decide to respond to the growing Middle East oil crisis that will have investors and consumers hoping for interest rate cuts alike on the edge of their seats when Powell steps up to the lectern at the central bank’s headquarters at 2:30 p.m. ET.
The price shock
When the U.S. and Israel attacked Iran on Feb. 28, the Islamic Republic responded in part by blockading the Strait of Hormuz, a crucial transit route for oil from the Middle East.
Overnight, the cost of crude oil soared. The price of gasoline quickly followed.
As of Wednesday, U.S. crude oil prices are up more than 40% and the average retail price of unleaded gas in the United States had risen more than 75 cents a gallon since the war began.
The diesel fuel that powers the ships, trucks and trains along America’s domestic supply chain topped $5 a gallon Tuesday for the first time since 2022.
“Heading into the March [Federal Open Market Committee] meeting, the key question for the Fed is how to handle oil price shocks,” wrote Morgan Stanley economists in a recent note.
Unlike last October, when the Fed voted to cut benchmark interest rates by a quarter point, this time the central bank is expected to keep rates steady.
“We expect no change in the stance of monetary policy at the March FOMC meeting,” economists at UBS wrote Friday, echoing the widely held expectations of economists and investors.
It’s not just oil and gas prices that are rising. The cost of jet fuel has soared, too, as has home heating oil.
Meanwhile, American consumers are already frustrated by the high cost-of-living. And news headlines about mass corporate layoffs reinforce the view that the U.S. labor market is in a fragile state.
“The vulnerable labor market faces more downside risks too, even as energy prices may point to higher headline inflation ahead,” wrote the UBS economists.
The Fed’s dual mandate, established by Congress, is to maintain maximum employment while keeping prices stable over the long-term.
“Powell will have his work cut out for him,” wrote Bank of America analysts.
A blurry economic outlook
Traditionally, central bankers “look through,” or discount short-term spikes in gas and oil prices, until they impact the price of other goods. Instead they primarily focus their attention on « core inflation, » a number that excludes the more volatile categories of food and energy prices.
That may not be possible this time, however. The already weakened state of the economy even before the conflict in the Middle East has increased Americans’ vulnerability to a domino effect of higher costs that begins with skyrocketing gas prices.
When an economic slowdown occurs at the same time as rising unemployment and higher inflation, it creates a dreaded scenario known as « stagflation. »
While the unemployment rate only ticked up fractionally in the most recent jobs report, overall the report showed a loss of 92,000 jobs for the month of February. It also contained sharp downward revisions to January and December’s jobs reports.
Inflation meanwhile, remains sticky, having come in at 2.4% in both January and February. That’s after falling from 3% in September.
Complicating the economic forecast even further is a new jolt of tariff uncertainty brought on by the Supreme Court’s Feb. 20 ruling that struck down many of President Donald Trump’s sweeping country-based tariffs.
Trump replaced those with a short-term global 10% tariff that he promised to raise to 15%, but so far has not.
In the meantime, the administration has quickly initiated dozens of probes into key trading partners, setting the stage for another wave of tariffs later this year.
A political cloud
As the central bank and Powell work to navigate the complicated economic situation, the Fed is simultaneously facing a set of political challenges that have no real equivalent.
In a case whose outcome could dramatically alter the independence of the Federal Reserve, the Supreme Court has heard oral arguments — but has yet to rule — on the future of Fed governor Lisa Cook, whom Trump has attempted to fire.
Also in legal limbo is a Justice Department probe into Powell and his testimony to Congress about Fed headquarters renovations.
Lawmakers on Capitol Hill were outraged to learn of the investigation, which Powell says is nothing more than an effort to pressure him into bowing to Trump’s demand that he back interest rate cuts at the Fed.
Until the probe is dropped, North Carolina Republican Sen. Thom Tillis has vowed to block the confirmation of the president’s pick to replace Powell as chair, economist Kevin Warsh.
Tillis met with Warsh recently in Washington and praised his qualifications, but he said the “bogus investigation” of Powell would nonetheless need to be dropped before Warsh’s confirmation process would move forward.
Powell’s second term as chair expires in May. Under normal circumstances, this March meeting would be his second-to-last in that position.
But it’s not clear yet when Warsh might be confirmed. The Justice Department has vowed to fight a federal judge’s order on Friday that had effectively ended the probe into Powell.
If Warsh still has not won Senate confirmation by May, then Powell will stay on in his current role as chair of the Fed’s rate-setting committee, at least until a nominee to replace him is approved by the Senate.
Source link
