In the entirely likely event that Kevin Warsh’s nomination for Fed chairman makes it through Senate hearings, he’ll be keen to leave his first Federal Open Market Committee meeting (FOMC) this summer with a base rate cut in-hand. After all, in order to land the nomination to succeed Jerome Powell the directive from the Oval Office was explicit: The candidate would have to be more dovish than Powell. Warsh, a former Fed Governor, fits the bill: He’s bullish on the U.S. economy, thanks in large part to the promise of AI, and is advocating for relative economic tightening on the Fed’s balance sheet to offset lower rates. Trump’s campaign against Powell’s central bank has been intense—he literally brought it to the doorstep of the Fed. Any incoming Fed chairman would be keen to set the tone early on, and deliver the much-requested rate cut the president has been lobbying for.
But to deliver that cut would be no mean feat. Trump’s military escapades with Israel in Iran are only likely to push an already skittish FOMC into a more hawkish stance, analysts believe. That’s because the biggest economic fallout from the conflict (notwithstanding the humanitarian toll) is the impact on energy supplies from the Gulf region.
Iran borders the Strait of Hormuz, a narrow waterway in the Persian Gulf through which exports from UAE, Qatar, Kuwait, and Iraq all flow. Shipmasters are now nervous to sail through it. The White House has suggested its military will offer escorts to ships along the strait in order to keep the route open, though whether that actually happens remains to be seen.
The knock-on effect for oil and gas prices is the key concern for economists. The Fed is tasked with keeping inflation at 2%, and consumer prices are already above-target on this metric. Lower the base rate would be adding fuel to that inflationary fire, by stoking consumption and borrowing.
Compounding the issue is the latest jobs data, which shows the labor market continuing to strengthen. Payroll provider ADP reported that private employers added 66,000 roles in February, well above the 50,000 expected. That doesn’t help the argument for a cut. The second part of the Fed’s mandate—steady employment—is already taking care of itself with little intervention.
Regional Fed Presidents, whose vote holds equal weight to that of the chairman, are already indicating that their wait-and-see stance is further warranted by the conflict. Cleveland’s president, Beth Hammack, said rates could be held for “quite some time,” with Iran presenting a new inflationary risk. Likewise, Minneapolis Fed President Neel Kashkari said this week he was growing less confident about his previous estimation of a 25bps cut this year, explaining: “With the geopolitical events, we need to get a lot more data in.”
Global bank hawks
Central bankers are approaching the Iran war as “hawks,” Macquarie’s Thierry Wizman said in a note to clients yesterday. As well as U.S. bankers, Wizman pointed to the fact that representatives from the Bank of Japan, Bank of England, the Bank of Canada, and the European Central Bank have also signalled they’re watching carefully for any inflationary hints.
“The prospect that the Fed may be ‘on hold’ instead of cutting rates this year may be why the USD has gotten an extra fillip of appreciation (beyond the haven-seeking impulse) during the war,” Wizman added. “With the OIS market previously projecting more than two cuts from the Fed in 2026 (as of last week) it is the U.S.’s rate outlook that is seen to have the greatest ‘potential’ to be overturned by another burst of global inflation in 2026, if energy supplies become constrained.”
The strong data meant investors are pricing out the likelihood of a cut in the first half of this year, noted Deutsche Bank’s Jim Reid this morning: “The probability of a cut by the June meeting (which would be the first with a new Chair) fell to just 39% by the close, the lowest so far this year. So clearly there’s growing scepticism that a new Chair can start cutting straight away, particularly with the data as strong as it is right now.”
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