Macquarie predicts the Federal Reserve's next policy move will be a rate hike, most likely in the first half of next year. Even if Kevin Warsh assumes the chairmanship by then, he would hold only one vote on the committee.
Just weeks ago, Wall Street was confident the Fed's policy path would shift toward easing. Market expectations pointed to benchmark rates steadily declining from their pandemic-era highs, with a clear drop below the current 3.5%–3.75% range anticipated.
Even before recent U.S. military actions involving Iran, this consensus was being challenged. Inflation remains stubbornly above the 2% target, and while the labor market shows signs of softening, it has not deteriorated enough to prompt significant action from the rate-setting Federal Open Market Committee (FOMC).
With the Middle East conflict showing no signs of a quick resolution, expectations for even a single rate cut this year are fading, despite this being the median projection among policymakers. Some economists now believe the FOMC's next move will be to raise rates.
The Middle East conflict significantly impacts the Fed's dual mandate by affecting key indicators for both businesses and consumers. Crucially, regional supply disruptions have driven up oil prices. The national average for gasoline has surpassed $4 per gallon, a direct transmission of rising international oil prices to American consumers.
Economists and analysts had widely hoped the conflict would conclude within weeks. However, the White House appears to be struggling to contain the situation. In just the past few days, Israel conducted an airstrike on Iranian oil facilities, prompting immediate retaliatory attacks by Iran on Qatar.
On March 19, Iranian Foreign Minister Seyed Abbas Araghchi stated on social media platform X that the retaliatory strikes utilized only a "fraction of Iran's capability." He added, "The sole reason for our restraint is respect for appeals for de-escalation. Should our infrastructure be targeted again, there will be no restraint." This suggests little chance of a near-term reduction in tensions.
The inflationary pressures from the conflict may persist longer than anticipated, implying the Fed may ultimately be unable to deliver the further rate cuts repeatedly urged by the White House.
In a client note following Chair Powell's press conference this week, David Doyle of Macquarie Group emphasized, "Aside from mentioning uncertainty around the economic impact of the Middle East conflict, changes to the Fed's statement wording were very limited."
Consequently, "we believe the next policy move will be a rate hike, most likely in the first half of 2027."
Although Doyle holds a more hawkish view among Fed watchers, he is not alone in this assessment. Gregory Daco, Chief Economist at EY-Parthenon, wrote on Wednesday, "Given upside inflation risks and a 'once-bitten, twice-shy' hawkish stance among most Fed officials, our base case is for only a 25-basis-point cut in 2026, most likely in December."
Even so, "it is entirely possible the Fed delivers no cuts this year, and the risk of the next policy move being a hike, rather than a cut, is not insignificant."
Could Even Warsh Change the Fate of Rate Hikes?
Investors appear to be leaning toward this view. According to the CME Group's FedWatch Tool, with over a month until the next FOMC meeting, interest rate traders are pricing in an over 87% probability of rates remaining unchanged in April.
For most of the past year, market expectations oscillated between a "hold" and a "cut," but the landscape has now shifted. Speculators have begun pricing in the possibility of a rate hike. As of this writing, traders assign a 50% probability of a Fed rate hike by October.
One factor that could alter these probabilities at future meetings is the arrival of a new Fed Chair: Kevin Warsh, nominated by the President. Although the timeline for Warsh's confirmation process remains uncertain, the market's clear assumption is that anyone succeeding Chair Powell would adopt a more dovish stance on monetary policy.
The President has explicitly stated that his nominee must be willing to implement rate cuts. Warsh could become an ally to Fed Governor Stephan Miran, who was also nominated by the President and has consistently argued for more aggressive rate cuts.
However, the rate hike Doyle forecasts for 2027 would likely occur during Warsh's potential tenure as chair, suggesting the incoming leader might be unable to deliver the swift rate cuts desired by the White House. Warsh's vote on the benchmark rate would be just one among many, though as Chair, his influence would carry significant weight, and markets would watch his guidance closely.
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