As Federal Reserve officials gather for their two-day policy meeting this week, the oil shock from the Iran war could deepen divisions with the central bank over the path forward on interest rates.<\/p>\n
\u201cI would love to see them quit focusing on when they can resume rate cuts because the path of inflation and other things to me were already uncertain,\u201d former Kansas City Fed president Esther George said in an interview.<\/p>\n
Read more: <\/em>How the Fed rate decision affects your bank accounts, loans, credit cards, and investments<\/em><\/p>\n \u201cNow is not the time to try to tease out where they think the neutral rate is because you’ve got a lot going on in this economy that could turn in a lot of different directions.\u201d<\/p>\n A few weeks ago, the big debate inside the Fed was how far rates are from neutral \u2014 a level on the Fed\u2019s benchmark policy rate designed to neither boost nor slow economic growth.<\/p>\n Fed officials were looking at an economy picking up tailwinds from tax refunds, low gas prices, a stabilizing job market, and fading tariff effects. Having cut rates three times last fall to steady the labor market, many Fed members were content to hold rates for the time being as they watched how things played out. Fed Chair Jerome Powell has said the central bank was within the range of estimates for neutral.<\/p>\n Now the picture is changing and will be defined largely by how long the war in Iran lasts and how long high oil prices linger. In recent comments, President Trump has given conflicting signals, saying the Iran war will be over \u201cvery soon,\u201d but that the US military campaign still has further to go. He also said that more important than domestic oil is stopping Iran from having a nuclear weapon.<\/p>\n Read more: <\/em>How oil price shocks ripple through your wallet, from gas to groceries<\/em><\/p>\n \u201cEven if you get this resolved in a month or two, you’re going to have the lingering effects of these higher prices going into the fall,\u201d George said.<\/p>\n With consumer spending accounting for 70% of economic growth, and consumers already under pressure from prices that have risen over the past five years, it won\u2019t take much to prompt a pullback, George added.<\/p>\n The oil price shock comes on top of inflation that has remained above the Fed\u2019s 2% goal for over five years, with tariffs pushing prices higher over the past year. The latest reading on inflation based on the Fed\u2019s preferred inflation gauge, the Personal Consumption Expenditures index excluding volatile energy and food prices, showed prices were sticky at 3.1% coming into the year, driven by rising services prices. Based on the Consumer Price Index, prices are rising more slowly at 2.5% as of February, before the Iran war.<\/p>\n<\/p><\/div>\n Even so, Wilmington Trust chief economist Luke Tilley told Yahoo Finance he thinks the discussion within the Fed will shift to whether monetary policy should be more accommodative, i.e., lower rates below the level of neutral.<\/p>\n \u201cResearch shows sustained high oil prices are a bigger risk to growth than to inflation,\u201d Tilley said. \u201cThe Fed will take a cautious stance and try to straddle the line and talk about the upside risks to inflation and also the downside risks to growth. \u201d<\/p>\n Read more: <\/em>How jobs, inflation, and the Fed are all related<\/em><\/p>\n Tilley estimates that if oil stays at $100 a barrel for three months, it will be close to tipping the economy into recession.<\/p>\n \u201cThe more you move from a one-week spike to a three-month spike in higher numbers, the bigger of a drag it is on the economy,\u201d Tilley said.<\/p>\n But former St. Louis Fed president Jim Bullard, now dean of the Mitch Daniels School of Business at Purdue University, isn\u2019t too worried about the impact of the oil shock for now because the US has transformed from a net importer of oil to a net exporter.<\/p>\n \u201cThe US has enough oil to be self-sufficient. So, from that perspective, you would think that it wouldn’t have that much impact on the US economy,\u201d Bullard said in an interview.<\/p>\n When it comes to inflation, while Bullard expects headline inflation to rise, he doesn\u2019t expect core inflation, which takes out volatile food and energy prices, to go up much. He also pointed to inflation expectations that are stable.<\/p>\n \u201cI think the committee will take comfort in that and say that their projections for inflation won’t change very much either,\u201d he said. \u201cSo despite this being a gigantic global issue, I don’t think that the US, given the information we have now, is going to be affected all that much.\u201d<\/p>\n George predicted that the spike in oil prices would draw the Fed\u2019s attention to inflation but would also gin up the argument that this is a temporary supply shock that the central bank could look through.<\/p>\n History shows that if the oil price shock comes from the supply side, it usually doesn’t lead to high \u201ccore\u201d inflation, but rather ends up hurting growth, according to Tilley.<\/p>\n While some policymakers could stick to their thesis of lowering rates, others who have raised caution about inflation could push off further rate cuts into next year.<\/p>\n At the last policy meeting, while several officials felt further rate cuts would make sense if inflation were to decline in line with their expectations, several others indicated that they would have supported a two-sided description of the Fed’s future interest rate decisions that would reflect the possibility that raising rates could be appropriate if inflation remains above the central bank’s 2% target.<\/p>\n Traders aren\u2019t pricing in the possibility of a rate cut until December, with the central bank widely expected to hold rates steady in the range of 3.5% to 3.75% on Wednesday.<\/p>\n With the meeting next week, officials will release the quarterly \u201cdot plot\u201d \u2014 a graph that charts how many interest rate cuts each Fed member sees for this year and next. But Wilmington Trust\u2019s Tilley says he\u2019s putting less weight on the interest rate projections given the uncertainty over the impact of higher oil prices, as well as tariffs \u2014 which now seem quaint, he added \u2014 and questions about the strength of the job market.<\/p>\n Read more: <\/em>The Fed\u2019s dot plot explained<\/em><\/p>\n \u201cThe dots will be all over the place given the different opinions within the committee,\u201d said Tilley. \u201cIt’s a really challenging time to put down a forecast. All the fundamental drivers are going to be changing pretty quickly, so I would expect a lot of dispersion in the dots.\u201d<\/p>\n Tilley says he believes the job market has stagnated, not stabilized. He\u2019s forecasting three rate cuts this year because he believes the job market is weak and GDP numbers are being overstated.<\/p>\n George, too, believes the job market is on what she called \u201cthin ice,\u201d noting that the Fed will have to wait and see.<\/p>\n \u201cI don’t think they feel good about either side of their mandate right now, even though the unemployment rate is low,\u201d she said.<\/p>\n Jennifer Schonberger is a veteran financial journalist covering markets, the economy, and investing. At Yahoo Finance she covers the Federal Reserve, Congress, the White House, the Treasury, the SEC, the economy, cryptocurrencies, and the intersection of Washington policy with finance. Follow her on X <\/em>@Jenniferisms<\/em> and on <\/em>Instagram<\/em>.<\/em><\/p>\n Click here for the latest economic news and indicators to help inform your investing decisions<\/strong><\/p>\n Read the latest financial and business news from Yahoo Finance<\/strong><\/p>\n<\/p><\/div>\n<\/div>\n<\/div>