Federal Reserve Interest Rate Decision Complicated by Iran War and Rising Energy Prices

As the Federal Reserve prepares to meet on March 18 for its next interest rate decision, Americans awaiting lower borrowing costs may face a longer wait due to the escalating conflict in Iran. The war has led to soaring oil and gas prices, which could push up transportation costs, food prices, and utilities, according to Wall Street analysts. With the Fed aiming to keep inflation at 2% annual target, the current situation poses a significant challenge for policymakers, who must balance the need to control rising prices with the necessity of supporting a labor market showing signs of fatigue.

How the Iran War Affects the Federal Reserve's Interest Rate Decision

The Iran war has significantly altered the economic landscape, making it increasingly difficult for the Fed to cut interest rates. Economists had initially predicted a steady benchmark rate at the March meeting, but many had expected a cut at the central bank's next meeting in June. However, with higher energy prices expected to ripple through the economy, the specter of higher inflation has led forecasters to revise their predictions, with some suggesting the Fed may not make any cuts in 2026.

Rising Energy Prices and Inflation Concerns

On March 13, the Fed's preferred inflation gauge, the Personal Consumption Expenditures index, showed that consumer prices crept higher in January, indicating that costs continued to rise even before the Iran war's impact on the energy sector. This development has increased concerns about inflation, with economists like EY-Parthenon chief economist Gregory Daco predicting a higher headline and core PCE inflation forecast. As a result, Daco has revised his baseline to show only one 0.25-percentage-point rate cut in 2026, likely in December, but notes that it is entirely plausible that the Fed won't deliver any rate cuts this year.

• The Fed is likely to hold its benchmark rate steady at 3.5% to 3.75% on March 18, with a 99% probability, according to CME FedWatch.
• There is a 95% probability that the Fed will maintain the current range at its April 30 meeting and a 77% likelihood that it will hold steady in June.
• Mortgage rates have risen since the start of the Iran war, with the benchmark 30-year fixed-rate mortgage rate increasing to 6.26% as of March 16.

Implications for Mortgage Rates and the Labor Market

The rising energy prices have also led to an increase in mortgage rates, which could further complicate the housing market. According to the Mortgage Bankers Association, the benchmark 30-year fixed-rate mortgage rate had dropped below 6% in late February but jumped to 6.26% as of March 16. This development may make it more challenging for homebuyers to secure affordable loans, potentially slowing down the housing market. Additionally, the labor market has softened, with employers shedding 92,000 jobs in February, marking an unexpected downturn. PNC economist Gus Faucher notes that this could create a dilemma for the central bank, as cutting the fed funds rate to support the labor market could lead to even higher inflation.

Challenges for the Next Fed Chief

The situation could also complicate life for the next Fed chief, with President Trump nominating former Fed official Kevin Warsh to succeed Jerome Powell as the central bank chair. Warsh, who must still be confirmed by the Senate, may face mounting inflationary pressures, making his job more challenging. EY-Parthenon's Daco notes that Warsh will need to demonstrate that his policy views are grounded in economic fundamentals rather than political considerations.

Key Takeaways

• The Iran war has led to rising energy prices, making it harder for the Fed to cut interest rates.
• Economists predict steady rates, with some forecasting no cuts in 2026.
• Mortgage rates have risen since the start of the Iran war, potentially slowing down the housing market.
• The labor market has softened, with employers shedding 92,000 jobs in February.
• The next Fed chief, Kevin Warsh, may face mounting inflationary pressures, making his job more challenging.

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