Federal Reserve "Spokesman" Delivers Major Signals Ahead of Meeting: Three Key Signals to Watch in This Week's Fed Decision!

As the Middle East situation once again disrupts the Federal Reserve’s anti-inflation efforts, Fed officials preparing for this week’s policy meeting may face a problem that seemed unlikely just a few months ago: not when the Fed will cut interest rates again, but whether they can convincingly keep the market believing that rate cuts are expected.

Nick Timiraos, a renowned journalist known as the “New Fed Correspondent,” said that the Middle East conflict is likely to reinforce the consensus that the Fed will keep rates unchanged. The more challenging issue is what signals officials will send about the future direction of interest rates in the coming months.

Timiraos believes there are three key points to watch in this week’s Fed decision:

First is the policy statement. In January, a few officials attempted to remove language hinting that the next move might be a rate cut, but were unsuccessful. If this change is made this week, it would mark the first explicit acknowledgment that the easing cycle may be over.

Second is the quarterly projections (including the dot plot), where 19 participants will each outline their expectations for inflation and interest rates over the coming years.

Third is the post-meeting press conference, where Fed Chair Jerome Powell may amplify or downplay any signals from the first two points.

Timiraos notes that the impact of the Iran war on energy markets is making the Fed’s job more complicated. In the short term, this widespread uncertainty almost guarantees that the Fed will hold steady, much like last spring after President Trump’s tariff announcement—when Powell used the phrase “wait and see” 11 times at the May press conference.

However, the numerous forecasts to be released this week will force officials to look ahead, making the outlook more unsettling. The geopolitical conflict broadens the range of possible economic outcomes but does not clarify which is most likely. If the conflict is contained, oil prices could fall; if it escalates, oil could surge further, threatening both inflation and economic growth.

UBS Chief U.S. Economist Jonathan Pingle said, “Those worried about inflation are now even more anxious. And those more focused on the labor market—probably—will have their concerns heightened rather than eased.”

The “Transient 2.0” Inflation Nightmare

Timiraos states that in response to oil shocks, central banks have traditionally advised to “ignore it”—believing that the economic impact and inflation push would roughly offset each other. But this advice relies on the public trusting that inflation will eventually fall back. After experiencing five years of above-target inflation and a series of shocks reminding consumers of rising prices, that trust is no longer a given.

“Do we really want to go through ‘Transient Inflation 2.0’ again?” Minneapolis Fed President Neel Kashkari said in an interview earlier this month. In December, he had expected one rate cut this year.

Part of the issue is that the U.S. economy is currently affected by multiple simultaneous shocks whose effects are intertwined. Besides tariffs and the looming oil shock, immigration-driven labor supply reductions have led to a phenomenon: despite sluggish job growth, the unemployment rate has hardly risen.

Former Boston Fed President Rosengren said that it’s difficult to disentangle the specific impacts of each shock on the economy, “making it hard for the Fed to make particularly decisive decisions.”

How far is the dot plot from a “zero rate cut” this year?

Timiraos points out that the dot plot forecasts are likely to dominate the market’s reaction to this week’s Fed meeting.

Last December, 12 of the 19 Fed officials expected at least one rate cut this year. But just three changing their views could bring the median forecast in the dot plot down to zero. Even if officials do not coordinate their forecasts as they do policy statements, this would be interpreted as the Fed signaling a prolonged pause in rate cuts.

Notably, markets have already adjusted rate expectations significantly ahead of the meeting. According to options prices calculated by the Atlanta Fed, as of last weekend, traders saw the probability of at least one rate cut before December drop to 47%, down from 74% before the Iran conflict began. Meanwhile, the chance of rate hikes by year-end has risen from 8% to 35%.

Timiraos emphasizes that with the upcoming leadership change at the Fed, the stakes are even higher: Powell’s term as Chair ends in May, so any plans made this week will serve as a foundation for his successor.

Additionally, if officials raise their inflation forecasts, the rationale for rate cuts becomes more difficult, especially for those who believe current rates are already near a level that neither promotes nor slows growth. For policymakers expecting inflation close to 3% by year-end, cutting rates when they are not yet restrictive is hard to justify.

On the other hand, for officials already concerned about the labor market—describing it as fragile or vulnerable—the Middle East conflict should heighten fears of economic downturn. Timiraos notes that up to three Fed governors might vote against rate cuts this week. If there is any difference, it is that the oil shock threatening to squeeze household budgets and weaken consumption actually provides more reason for them to keep the option of easing on the table.

Timiraos concludes that regardless of the forecast outcomes, a deeper change may lie in the Fed’s future ability to preemptively guard against risks. Over the past two years, when labor markets showed signs of weakness, officials cut rates, confident in their inflation outlook and willing to “insure” against an upcoming recession.

But this trade-off now faces the risk of breakdown.

“The Fed tends toward easing policies. That’s the general direction,” said Vincent Reinhart, a former senior Fed advisor and now Chief Economist at Mellon Investment Management in New York. “But they won’t cut rates until they are confident that inflation has permanently fallen back.”

(Article source: Caixin)