With Middle East tensions once again severely disrupting the Federal Reserve's inflation-fighting progress, officials gathering for this week's policy meeting may face a question that seemed unlikely just months ago: not when the Fed will cut rates again, but whether they can still credibly signal that rate cuts are expected. Nick Timiraos, a prominent journalist often referred to as the "New Fed Whisperer," noted that the Middle East conflict likely reinforces the consensus expectation that the Fed will keep rates unchanged. The more challenging issue is what signals officials will provide about the interest rate trajectory beyond the coming months.
Timiraos highlighted three key focal points for this week's Fed decision. First is the policy statement. In January, a few officials attempted, unsuccessfully, to remove language suggesting the next policy move would be a rate cut. If such a change is made this week, it would mark the first clear acknowledgment that the easing cycle might be over. Second are the quarterly projections, including the "dot plot," where 19 officials will each provide their forecasts for inflation and interest rates in the coming years. Third is the post-meeting press conference, where Chair Jerome Powell may amplify or downplay any signals from the first two items.
Timiraos pointed out that the impact of the Iran conflict on energy markets is complicating the Fed's task. In the short term, the pervasive uncertainty almost ensures the Fed will stand pat, similar to how officials waited after last spring's tariff announcements—Powell used the phrase "wait and see" 11 times during last May's press conference. However, the numerous projections to be released this week will force officials to look ahead, making the outlook more unsettling. The geopolitical conflict has widened the range of potential economic outcomes without clarifying which is most likely. If the conflict is contained, oil prices could fall; if it escalates, prices could surge further, threatening both higher inflation and slower growth.
Jonathan Pingle, Chief US Economist at UBS, stated, "Those who were worried about inflation are going to be more worried. And for those more focused on the labor market—this probably adds to their concerns rather than alleviates them."
Confronting an oil shock, central banks have historically advised to "look through" it, assuming the growth drag and inflation push would roughly offset. This advice, however, relies on public belief that inflation will eventually subside. After five years of above-target inflation and repeated price shocks, that confidence can no longer be taken for granted. "Do we really want another 'transitory 2.0'?" Minneapolis Fed President Neel Kashkari remarked in a recent interview. In December, he had projected one rate cut this year. Part of the problem is that the US economy is facing multiple simultaneous shocks whose effects are inseparable. Beyond tariffs and the looming oil shock, immigration restrictions reducing labor supply have created a situation where job growth is sluggish yet unemployment has barely risen. Former Boston Fed President Eric Rosengren noted that the inability to isolate each shock's impact "makes it very difficult for the Fed to be particularly decisive."
Timiraos indicated that the dot plot projections will likely dominate the financial market's reaction to this week's meeting. In December, 12 of the 19 officials projected at least one rate cut this year. A shift by just three officials could lower the median dot to zero cuts. Even though projections aren't collectively planned like the policy statement, such an outcome would be interpreted as a signal for a longer pause on rate cuts. Notably, markets have already significantly adjusted rate expectations. According to Atlanta Fed calculations based on option prices, traders' probability of at least one cut by December fell to 47% last weekend, down from 74% before the Iran conflict began, while the chance of a rate hike by year-end rose from 8% to 35%.
With upcoming leadership changes at the Fed—Chair Powell's term ends in May—the stakes are higher, as any plans set this week will form the baseline for his successor. Furthermore, if officials raise their inflation forecasts, the rationale for planned rate cuts becomes logically harder to justify, especially for those who believe rates are already near a neutral level. For policymakers expecting year-end inflation near 3%, cutting rates when policy isn't considered restrictive is very difficult to justify. Conversely, for officials already uneasy about the labor market—described as fragile or vulnerable—the Middle East conflict should heighten concerns about economic downside risks.
Timiraos noted that up to three Fed governors might still dissent in favor of rate cuts this week. If anything, an oil shock that threatens to squeeze household budgets and weaken consumption could strengthen their argument for keeping the option of rate cuts available.
Regardless of the projections, a deeper shift may be the Fed's reduced capacity for preemptive action. For much of the past two years, officials cut rates when labor market weakness appeared, confident enough in the inflation path to buy "insurance" against a potential recession. That trade-off now risks breaking down. "The Fed has a bias to ease. That's the direction," said Vincent Reinhart, a former Fed senior advisor and current Chief Economist at Dreyfus and Mellon. "But they are not going to cut until they are confident that inflation is durably coming down."
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