Fed Holds Rates Steady, with Eyes on Iran

Key Highlights:

• The FOMC held rates steady at 3.5%–3.75%, as expected, with Chair Powell emphasizing that the Iran war and potential oil shock create enough uncertainty to limit the value of current economic forecasts
• The Fed’s bias going into this war is clearly toward gradual cuts—about 50 bps over the next 12–18 months to a roughly neutral 3%–3.25%
• Powell clarified that he would remain as interim chair if needed until Kevin Warsh is confirmed and would stay on as a governor if the DOJ construction-cost investigation remains unresolved, underscoring both the seeking of continuity and also the element of unusual political drama at the Fed

Rates on Hold, With a Cutting Bias

As had been universally expected coming into the March meeting, the FOMC decided to hold rates steady at 3.5%–3.75%.

The pre-war labor market and price backdrops are fairly enough balanced, but the war in Iran leads to a large amount of uncertainty in the economy. Given that uncertainty around current events and their macroeconomic implications, namely their impact on inflation, the rest of the FOMC’s materials are of limited use. They updated their economic projections, but events on the ground could overwhelm the economic basis on which those have been made. Chair Powell referenced that point in his comments, suggesting the forecasts are of limited use when we can’t be sure of the impact of the oil shock. He did note, however, that the FOMC believes they’re well positioned to take action once that impact becomes clear, which is about as much as he can reasonably offer at this stage.

Taking the Fed’s projections at face value, though, they suggest a path of gradual rate cuts over the medium term—around half a percentage point over the next year and a half. No members of the committee foresee a hike this year and only one does for next year. Thus, the bias is clearly toward further cuts. The question will be how the Fed handles any oil price shocks that begin to boost inflation—will it look through them or consider hikes to nip inflation in the bud again?

Hikes are potentially back on the table, but the much more probable set of events would lead the Fed to maintain rates at their current level for longer, rather than starting another hiking cycle.
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We continue to expect around that same half-percentage-point of cuts over the medium term. Such a path would bring the rate to 3%–3.25%, which is a reasonable estimate of the neutral rate. If the war persists, the Fed could stay on hold longer. But it’s too early in the conflict to say with any confidence.

Musical Fed Chairs

Given the unusual political forces being put to work on the Fed by the executive branch and the upcoming confirmation process for the White House’s Fed Chair nominee, Kevin Warsh, further clarification by Chair Powell is also notable. He indicated that if Warsh is not confirmed by the time his chairmanship ends, he will stay on as temporary chair until Warsh is confirmed, in line with the law and past precedent. Also, given the ongoing DOJ investigation of the Fed’s construction costs, Powell indicated that if that investigation is not fully and permanently completed by the time he steps down as chair, he will remain on as a governor after the new chair is seated. He did not indicate what he would do if Warsh is confirmed and the investigation is satisfactorily concluded, though we expect he would then stand down as governor, even if he wasn’t willing to make that commitment at the present time.