Will the US-Iran conflict become the "interest rate cut dream" and a game-changer? The Fed's second-in-command once again pours cold water on the idea

On Thursday evening local time, Federal Reserve Vice Chair Philip Jefferson stated that he expects the Iran-Israel conflict to drive up inflation in the short term, while monetary policy “is prepared to respond to various economic outcomes.”

During a speech in Dallas that day, he said, “At least in the short term, I expect overall inflation to rise, reflecting the increase in energy prices caused by the Middle East conflict.”

“Looking ahead, I believe the current policy stance allows us to better determine the magnitude and timing of further adjustments to the policy interest rate.” He added.

Jefferson is closely monitoring the situation in the Middle East and the global energy market, but he noted that it is still too early to judge the impact on the economy. He emphasized that the effects of the Middle East conflict largely depend on the duration of high energy prices: brief disruptions are unlikely to have a significant impact on the economy beyond one or two quarters, but sustained high oil prices could have substantial effects.

Coincidentally, Federal Reserve Governor Michael Barr also pointed out that recent shocks, from soaring oil prices to tariffs, have made the Fed’s efforts to reduce inflation to 2% more complicated.

He also believes that if the conflict ends quickly, the impact on inflation and the economy may be limited; however, if the conflict continues, it could have broader implications for both. Barr is concerned that inflation has remained above the Fed’s target for five consecutive years and fears that if oil prices continue to surge, it could raise long-term inflation expectations.

“Given the potential for developments in the Middle East to create significant uncertainty for our economy, along with the other factors I mentioned, it is reasonable to take some time to assess the situation. Our current policy stance puts us in a good position to maintain stability.” He added.

Inflation Impact

Jefferson also stated that so far, the impact of rising oil prices on inflation should be relatively small, although consumers are indeed seeing higher gasoline prices at the pump now. He is closely watching whether these higher costs will reflect in the price system of the overall economy.

On the other hand, the longer energy prices remain high, the more households will need to make trade-offs. Jefferson warned that families relying on oil and gas for commuting, schooling, and heating may have to cut back on non-essential spending. This could lead to reduced spending at restaurants or retail stores, while also potentially increasing household debt levels.

He also noted that the ongoing uncertainty surrounding tariff policies and the recent surge in energy prices have made the economic landscape more complex for the Fed in terms of addressing inflation and maintaining full employment.

Before the outbreak of the conflict in Iran, the U.S. inflation rate had been above the Fed’s 2% target for five consecutive years, and progress in reducing inflation seems to have stalled over the past year. Jefferson primarily attributed this to tariffs but also pointed out that inflation in the service sector, excluding housing, has remained relatively stable over the past year. However, strong productivity growth and deregulation have somewhat offset this impact.

Labor Market

Additionally, Jefferson stated that the labor market is “roughly balanced,” but the risks are “tilted to the downside.” He noted that the unemployment rate is expected to remain around 4.4% this year, but overall employment growth may still be low. He indicated that when assessing the health of the labor market, he will closely monitor the speed and composition of new job creation.

However, he believes that the pace of economic expansion remains steady compared to last year or slightly faster, but also pointed out that there is considerable uncertainty in the outlook.

“The current economic situation is highly uncertain, and rising energy prices and escalating conflict in the Middle East have exacerbated this uncertainty. But I still believe that our current policy stance is appropriate and allows us to assess the direction of the economy,” he added.

(Source: Caixin)