Federal Reserve "Hawks" Sound Loud and Clear: No Rate Cuts Without Inflation Decline, Rate Hikes Possible

Question AI · How does the Middle East situation affect the Federal Reserve’s rate cut timetable?

Jiemian News Reporter | Liu Ting

Early Thursday Beijing time, the Federal Reserve announced it would keep the federal funds rate target range unchanged at 3.50%-3.75%. At the same time, the released dot plot shows that Fed policymakers expect one rate cut this year and another in 2027.

The decision to hold rates steady was expected, but inflation expectations have clearly risen. Of the 19 FOMC members participating in the dot plot, 7 do not expect a rate cut this year, up by 1 from December last year.

Fed Chair Jerome Powell said at the press conference that U.S. inflation remains stubborn, and the outlook is uncertain. Variables such as the Middle East situation and tariff disruptions are disrupting the pace of inflation decline. Until further cooling is seen, rate cuts are not being considered. He also mentioned that the FOMC has begun discussing the possibility of raising rates again, although this is not the baseline scenario for most officials.

Since the escalation of Middle East tensions in late February, international oil prices have surged sharply, with Brent crude futures rising from around $72 per barrel before the conflict to over $100. According to Morgan Stanley, a 10% increase in oil prices would directly raise U.S. inflation by about 0.3 percentage points, and current actual increases have far exceeded this level. The Fed also added in its policy statement that “developments in the Middle East pose uncertainties for the U.S. economy.”

The latest Fed quarterly economic forecast shows that the median forecast for the PCE inflation rate in 2026 has been raised from 2.4% to 2.7%, and core PCE from 2.5% to 2.7%. Inflation expectations for 2027 have also been slightly increased.

Meanwhile, the Fed’s outlook on employment appears more optimistic. The policy statement changed its wording from “signs of stabilization in the unemployment rate” in January to “the unemployment rate has been relatively stable in recent months.” Powell stated that while there are downside risks to the labor market, multiple indicators show some degree of stability.

Analysts believe that under the dual pressures of soaring energy prices and stubborn core inflation, the Fed’s policy tilt has clearly shifted toward inflation concerns when considering rate cuts.

“Powell’s comments suggest that the threshold for employment weakness triggering rate cuts has been raised. In the face of geopolitical risks, the first rate cut this year is likely delayed until at least June, with a higher probability of resuming in the second half,” said Jin Xiaowen, Chief Macro Analyst at PuYin International, to Jiemian News. She maintains her forecast of two rate cuts this year, each by 25 basis points, but notes that stagflation risks could lead to smaller actual cuts than expected.

Influenced by Powell’s hawkish stance and escalating Middle East tensions, U.S. stocks plunged across the board on Wednesday. The Dow fell 1.63%, the S&P 500 declined 1.36%, and the Nasdaq dropped 1.46%. Since the escalation of Iran-related tensions, market focus has shifted from AI boom and “soft landing” expectations to pricing in geopolitical risks and stagflation threats.

Despite concerns over stagflation, most analysts agree that it’s too early to conclude the U.S. is in stagflation.

Fitch Chief Economist Brian Coulton told Jiemian News that rising oil prices combined with weaker-than-expected employment growth do raise stagflation worries, but several buffers are worth noting. First, the economic weakness in Q4 2025 was mainly due to temporary government shutdowns, and GDP growth is expected to rebound significantly in Q1 2026. Second, consumer spending remains robust, with household incomes slightly rising. Third, investment in AI continues actively. Additionally, fiscal policy is showing signs of easing again.

Coulton emphasized that current overall inflation pressures are much lower than mid-2022 — when oil prices also exceeded $100 per barrel — a period marked by supply chain disruptions, soaring non-energy commodity prices, and severe labor shortages, compounded by large-scale fiscal easing and ultra-low interest rates. Currently, the labor market is cooling, and wage growth has entered a downward trend.

Bai Xue, Senior Deputy Director of Research and Development at Orient Securities, told Jiemian News that although U.S. inflation risks are becoming more apparent, the economy remains resilient and has not entered a substantive stagnation. The main sources of current inflation risk are twofold: short-term supply shocks — such as soaring oil prices driving energy prices higher; and long-term cost pass-through — tariffs increasingly transmitted to end consumers.

On the growth side, Bai believes the slowdown is clear but not to the point of stagnation. She pointed out that the weak non-farm payrolls in February were mainly due to temporary factors, not a sign of declining growth momentum. While companies are cautious in hiring, large-scale layoffs have not occurred. Additionally, the U.S. real GDP growth rate for Q4 2025 was sharply revised downward from 1.4% annualized to 0.7%, with the full-year growth lowered to 2.1%, the lowest since 2021. However, Bai noted that this revision reflects temporary factors: on one hand, tariffs disrupting trade; on the other, phased government spending cuts, rather than a complete loss of private sector momentum.

Overall, balancing inflation control and economic stability makes Fed policy decisions more complex. On one hand, rising inflation risks from energy prices and tariff pass-through are accumulating; on the other, slowing growth limits tightening.

The latest dot plot indicates one rate cut this year and another in 2027, but Powell’s firm stance that “no rate cuts until inflation improves” means this path depends on actual inflation decline. With ongoing Middle East conflicts and tariff impacts, whether inflation can fall as desired remains uncertain.

However, some analysts still believe the Fed will cut rates more than once this year.

Bai expects the Fed to mainly observe data in the first half, with the possibility of 1-2 rate cuts in the second half, depending on geopolitical developments and economic recovery. She emphasized that short-term geopolitical shocks do not change the monetary policy direction, as the recent inflation rebound is mainly driven by external shocks — oil prices due to conflicts — rather than domestic demand. Core inflation excluding food and energy is relatively moderate, and rising oil prices not only boost inflation but also restrain U.S. economic growth.

Kathy Wu, North America Deputy Chief Economist at Capital Economics, also told Jiemian News that the FOMC statement and dot plot are less hawkish than expected. Despite raising inflation forecasts, they still project only one rate cut this year, indicating the FOMC is unlikely to overreact to the short-term inflation spike, especially under Kevin Waugh’s leadership as Fed Chair, which will make this trend more evident.