Volkswacht Bodensee - US Fed expected to hold rates steady as Iran war's shockwaves ripple

The Fed began its two-day meeting on Tuesday, which will culminate in an announcement of the benchmark lending rate in the world's largest economy, expected at 2:00 pm US Eastern Time (1800 GMT) on Wednesday.

The central bank will also release its quarterly Summary of Economic Projections, where its outlook for GDP growth, inflation and unemployment will be closely watched for potential downward revisions.

The Fed cut rates three consecutive times last year before holding them steady at its January meeting.

It has a dual mandate of maintaining inflation near a long-term target of two percent while ensuring maximum employment.

With war in the Middle East causing global oil prices to spike, potentially fuelling inflation and curbing growth, analysts say policymakers are unlikely to make any immediate moves.

"The Fed is in a really tough spot right now," said Wells Fargo economist Nicole Cervi. "They need to choose what side of the mandate to prioritize, because they're not hitting either goal."

While consumer inflation has dropped from a peak of 9.1 percent during the Covid pandemic, it remains well above the Fed's target, leaving households battered by years of price increases.

"Unlike other countries, which have already achieved some level of price stability," the United States has yet to reach this point after five years, said Diane Swonk, chief economist at KPMG.

She warned that, depending on how long the Iran war lasts, inflation could again soar past four percent.

Affordability has been a key political issue for US President Donald Trump, who has repeatedly called for rates to be slashed even as prices have remained stubbornly high.

US average gasoline prices have increased around 27 percent since the start of the war, according to the AAA motor club's gauge.

"I think the main story here is that we are seeing inflation moving away from the Fed's two-percent target, and that will lead many Fed policymakers to adopt an even more hawkish stance," said EY-Parthenon chief economist Gregory Daco, who want to raise rates to curb inflation.

- Uncertainty 'tax' -

Raising rates to cool the economy, however, could bring the Fed into tension with its other mandate: managing unemployment.

The United States unexpectedly lost 92,000 jobs in February, government data showed, while the unemployment rate rose to 4.4 percent.

Analysts say a relatively steady unemployment rate has been masking churn beneath the surface -- with sluggish labor demand covered by a drop in supply due to Trump's immigration crackdown.

Daco said labor demand gauges were showing a hiring rate "at a decade low" and slowing wage growth.

Swonk noted that uncertainty due to the Iran war and its knock-on effects would further curb labor demand.

"Uncertainty acts as its own tax on the economy, and one of the first lines of defense that firms do is they freeze hiring," she said.

Recent data ahead of the Fed meeting is not encouraging, with US GDP growth revised sharply lower in the final months of 2025.

- 'Splintered Fed' -

Central banks tend to ignore the inflation effects of short-term price shocks, but it is unclear how long the war in Iran will drag on.

Before the war, a rate cut was expected as soon as the summer, with another possible later in the year.

On Tuesday, CME's FedWatch tool showed expectations of just one rate cut by year-end, likely coming after September.

Swonk warned that any economic slowdown from the war could be tough to recover from in the immediate term and supply disruptions would affect more than energy prices.

Speaking to AFP, Nobel prize-winning economist Joseph Stiglitz had similar warnings, particularly for the crucial fertilizer sector which impacts food prices.

Stiglitz said that even before the war, the US economy was "close to stagflation," a dangerous combination of inflation and economic contraction.

While traders generally expect the Fed to hold rates steady, the heightened uncertainty could lead to more polarization among policymakers.

"I wouldn't be surprised to see a much more splintered Fed, where someone even puts a rate hike in their forecast because of the lingering effects (of the war)," said Swonk.

K.Hofmann--VB