U.S. interest-rate expectations have shifted as the war in Iran has fed through energy prices and, in turn, inflation concerns and longer-term rates, influencing borrowing costs from mortgages to business lending. The change has made this year’s odds of Federal Reserve rate cuts fade, with investors increasingly viewing an actual rate hike as more plausible than earlier in the year. (AP)
Since the war began Feb. 28, longer-term interest rates have risen quickly, pushing up the cost of mortgage loans, auto loans, and other borrowing that depends on market yields. As those longer-term rates move higher, lenders typically pass the increased funding costs through to consumers, including households seeking new mortgages or refinancing. (src_001)
Market pricing has also moved in the opposite direction from the “cuts” debate that dominated early in the year. Krishna Guha, head of economics at Evercore ISI, wrote Tuesday that cuts have not been eliminated so much as postponed—“delayed, not derailed,” he said, while laying out a range of possible deferral windows. (src_001)
Federal Reserve officials have added to the sense that the policy path may be sensitive to inflation and expectations. In an interview with The Associated Press on Monday, Austan Goolsbee, president of the Federal Reserve Bank of Chicago, said that if inflation rose while unemployment stayed stable and Americans showed signs of anticipating higher inflation, “then there is an obvious playbook, which is rate increases have to be on the table.” Goolsbee participates in discussions of the Fed’s rate-setting committee, though he is not one of the 12 voters this year. (src_001)
Investors have adjusted their forecasts accordingly. Futures pricing tracked by CME Fedwatch showed no longer foreseeing any rate reductions this year, according to the AP story, and it reported that odds of a rate hike by October rose to nearly 25%, up from zero a week earlier. In parallel, longer-term rates rose further as investors expected the Fed to keep its short-term rate higher for longer. (src_001)
Another factor complicating the Fed’s decision is the growth tradeoff created by energy-price shocks. The AP reported that most economists expect the conflict to worsen inflation by lifting gas prices, but that if energy prices rise for an extended period, consumers could cut back on spending elsewhere to absorb the higher gas costs, potentially slowing the economy and pushing unemployment higher. (src_001)
Federal Reserve Chair Jerome Powell, speaking last week, acknowledged that the central bank has found it “more challenging” to assume the impact would be temporary given that inflation has been above its 2% target for five years. That backdrop has contributed to why Fed officials, in the near term, have focused on the threat of higher inflation while considering how quickly any labor-market weakness might appear. (src_001)
The AP also cited specific rate indicators and borrowing costs that reflect the higher-rate environment. It said the yield on the 10-year Treasury note moved from just below 4% on Feb. 27—the day before the Iran war began—to nearly 4.4% by Wednesday. In addition, Freddie Mac data showed 30-year fixed-rate mortgages averaging 6.22%, up from just below 6% before the war; for this article’s date, the verified 10-year Treasury yield stands at 4.34% (DGS10) and the verified 30-year fixed mortgage rate is 6.22% (MORTGAGE30US). (src_001)
In a written statement late Monday, Mary Daly, president of the San Francisco Fed, said the uncertainty created by the Iran war means “there is no single most-likely path” for the Fed’s key interest rate, suggesting the Fed could move up, down, or remain unchanged over the coming months. The statement came amid ongoing debate about how quickly energy-driven inflation pressures may fade and whether labor conditions remain strong enough to allow policy to stay restrictive. (src_001)
Economists cited in the report described the dilemma as both inflation-positive and growth-negative. Jonathan Pingle, an economist at UBS, said “On net more inflation means probably higher rates,” while also describing the energy shock as a headwind to growth. That tension helps explain why the Fed’s usual framework—raising rates to fight inflation, cutting rates when unemployment worsens—could face a more difficult balancing act if gas prices keep pressuring prices and household demand at the same time. (src_001)