THE US Federal Reserve’s pause in interest-rate cuts is beginning to look more like a full stop these days.
The stage was set for another Federal Reserve pivot this week, but Israel’s ongoing attacks on Iran are likely to have chairman Jerome Powell erring on the side of hawkishness once again.
At the end of the Fed’s next meeting on Wednesday (Jun 18), the central bank is almost certain to leave rates unchanged in a range of between 4.25 and 4.5 per cent. During his customary press conference and in the Fed’s “dot plot”, Powell could disabuse investors of their hopes for rate cuts later in the year.
Hopes for a return to rate cuts following a six-month hiatus had mounted earlier this month following the latest in a series of muted inflation data. Both consumer prices and wholesale prices barely changed in May from a month earlier – a promising sign.
Much of that optimism was washed out, however, after Israeli Prime Minister Benjamin Netanyahu on Jun 13 ordered strikes on Iranian nuclear facilities and senior military leaders.
In response, Iran shot a volley of missiles at Israel. Iran’s Supreme Leader Ayatollah Ali Khamenei promised that his oil-producing nation would wreak vengeance. The conflict drove up oil futures by as much as 10 per cent on Jun 13.
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Ordinarily, such a move would be catastrophic for the US economy, coming at the beginning of the key summer travel season. Nearly all US recessions in the last century have been preceded by a spike in oil prices.
This time around, there is some elbow room on inflation due to the fact that oil had been wallowing near multi-year lows as recently as May.
Even after the Israeli attacks, the price of oil peaked at around US$74 a barrel, roughly in line with 10-year average prices. Should oil remain near that level, US consumers would see gasoline prices rise to roughly US$4 a gallon – a level where demand has not been too severely dented in the past.
Still, there are reasons for the Fed to wait until the scale of war in the Middle East and elsewhere becomes clearer.
“The primary market concern lies with Iran potentially closing the Strait of Hormuz, a critical choke point for global oil and gas,” said Kristian Kerr, head of macro strategy at brokerage LPL Financial.
He said Iran was unlikely to take this drastic step because of its reliance on the waterway for exports to China, the nation’s main economic lifeline. A bigger risk is an Israeli attack on Iranian oil infrastructure, Kerr said. That could drive oil futures above the psychologically significant US$80-per-barrel level.
More worryingly, observers said the web of alliances fashioned by China to counter US military dominance could result in a broader regional or global conflict.
“Some fear that if the situation escalates, the relationships that Iran has with China and Russia could domino into a literal World War III,” said Louis Navellier, a veteran Wall Street strategist.
If the Israel-Iran war is one thing that will give Powell reason to pause, the ongoing US-China trade war is another.
Last week, the Trump administration claimed that high-level talks in London had returned trade negotiations with China to a promising path. It’s unclear, however, if the temporary suspension of extreme tariffs will become permanent when the truce expires in about a month.
The Fed has long maintained that it will have to see final trade agreements, and their impact on prices and economic demand, before changing policy. Investors have taken that vow with a pinch of salt, for it seems likely the Trump administration will move the tariff goalposts indefinitely.
So far, predictions that US President Donald Trump’s global trade war would reignite the 2023-24 inflation inferno have not come to pass. Economists said it’s still early in the jockeying between the world’s two largest economies for the Fed to be sure of its impact on inflation.
“After accumulating inventories in the first quarter (ahead of tariffs), we think firms might be delaying price increases to remain out of the spotlight and preserve market share,” said economists at Bank of America Global Research in a note to clients.
“This means that the inflationary impact of tariffs could be more protracted and not just a one-off. Fed cuts will still have to wait.”
For example, auto prices have only inched up slightly this year. But steel and aluminum tariffs of 50 per cent, and the blanket 10 per cent duty on imports, including European cars, are bound to cause much more significant moves in US car prices before the end of the year.
The Bank of America economists expect the Fed to sit on its hands until 2026. If gasoline and import prices start to rise rapidly, however, rate cuts could be delayed even further.
