MNI FED WATCH: Watch And Wait As War Stokes Two-Sided Risks

The Federal Reserve is widely expected Wednesday to keep benchmark rates in a 3.5-3.75% range for a second straight meeting as officials monitor the Iran war for threats to both their price stability and maximum employment goals. 

After three cuts late last year to buy insurance for a cooling labor market, the Fed faces a stagflationary shock that will likely delay further downward moves. Oil prices have surged, on top of the latest PCE inflation report that showed core inflation sticky at 3.1% in January. 

Updated economic projections could show slightly higher inflation and unemployment for the year, though the median projection among FOMC members will likely stay at one cut for 2026, former Fed officials told MNI. (See: MNI: Fed Dots To Stay At One Cut For 2026 - Ex-Officials)

"This is the most unappetizing central bank problem, which is the likelihood that both the labor market weakens and that inflation goes up. And the problem is that it's not quite unclear at this point how long the hostilities in the Persian Gulf are going to continue," former Boston Fed President Eric Rosengren told MNI. (See: MNI INTERVIEW: Fed On Pause Amid Two-Sided Risks - Rosengren)

"I expect the FOMC to stay on hold. Unless there becomes a little bit more certainty during the war, it's a very difficult position for the Fed to make decisions." (See: MNI INTERVIEW: Fed On Sidelines, Awaiting Clarity - Kaplan)

INFLATION WORRIES

The stagflationary risk from President Trump's tariffs last year had kept the Fed on hold for nine months in 2025, and even those effects have not fully washed out of the economy, with core goods PCE inflation printing 0.3% in January, far higher than pre-pandemic levels, and unemployment rising two-tenths since April. (See: MNI POLICY: Fed Embraces Pause As Downside Labor Risks Abate)

Core services price pressures are stubbornly elevated as well, underpinning concern from the inflation hawks on the committee, several of whom supported a "two-sided description" of future rate moves in a nod to "the possibility that upward adjustments to the target range for the federal funds rate could be appropriate if inflation remains at above-target levels," according to minutes of the January FOMC meeting. (See: MNI INTERVIEW: Fed Pause Reinforced By Iran Shock - Fuhrer)

A scenario in which the war is prolonged and the Strait of Hormuz shut for some time would have worrisome impacts on consumer confidence and inflation expectations, which could shift the Fed's reaction function even if the economy shows resilience, former Atlanta Fed President Dennis Lockhart told MNI. (See: MNI INTERVIEW: Fed Hike Still Unlikely Base Case - Lockhart)

One-year gas price expectations are the highest since 2022 when Russia invaded Ukraine, according to the University of Michigan's latest Survey of Consumers. Consumer sentiment was improving in late February but quickly soured with price expectations surging as the Middle East conflict broke out, the head of the UMich survey, Joanne Hsu, told MNI. (See: MNI INTERVIEW: US Price Expectations Jump On Iran War - UMich)

LABOR MARKET SOFT

The employment situation continues to worry policymakers as well. Despite Fed officials saying the labor market has stabilized at the start of the year, a negative shock to the precarious low-hire, low-fire environment could tip the situation in favor of more layoffs. 

Average monthly payrolls growth has been just modestly above zero over the past few months and job growth is concentrated in health care. Outsized investment in AI has also drawn attention to streamlining workforces, especially in tech sectors. (See: MNI POLICY: AI Boom Complicates Fed's Path To Lower Rates)