Summary

The jump in gas prices tied to the war in Iran is feeding through to U.S. interest rates—and is reshaping expectations for Federal Reserve policy, with implications for borrowing costs from mortgages to auto loans.

Since the conflict began Feb. 28, longer-term interest rates have risen quickly, helping push up the cost of mortgage loans, as well as other forms of lending. With inflation measures likely to rise in coming months, the outlook for Federal Reserve rate cuts this year has dimmed, and Wall Street investors are increasingly pricing in the possibility of a rate hike.

Krishna Guha, head of economics at Evercore ISI, wrote Tuesday that “We think cuts are delayed, not derailed,” adding that the decision would be pushed “delayed to September, delayed to December, or delayed more indefinitely” into 2027.

Austan Goolsbee, president of the Federal Reserve Bank of Chicago, said in an interview with The Associated Press Monday that if inflation were to rise while the unemployment rate remained stable—and if Americans showed signs of anticipating higher inflation in the future—there would be “an obvious playbook,” meaning that “rate increases have to be on the table.” Goolsbee participates in meetings of the Fed’s rate-setting committee but is not one of the 12 voting members this year.

Investors’ expectations have shifted as well. According to CME Fedwatch futures pricing cited by AP, Wall Street no longer sees rate reductions this year, and the odds of a rate hike by October have risen to nearly 25%, up from zero a week earlier.

Late Monday, Mary Daly, president of the San Francisco Fed, said in a written statement that the uncertainty created by the Iran war means “there is no single most-likely path” for the Fed’s key interest rate, suggesting policymakers could move the rate up, down, or leave it unchanged in the months ahead.

The war has left the Fed facing a difficult tradeoff: while many economists expect the conflict to worsen inflation by lifting gas prices, high energy costs can also curb spending elsewhere, potentially slowing the economy and raising unemployment. The Fed typically raises rates—or keeps them unchanged—to combat inflation, and cuts rates to spur the economy and lower unemployment.

Jonathan Pingle, an economist at UBS, said, “On net more inflation means probably higher rates,” while adding, “On the other hand, that energy price shock is going to be a headwind to growth.” He framed the policy problem as balancing inflation pressures against growth headwinds.

Under typical conditions, central banks may look past a temporary spike in inflation from energy prices. But Jerome Powell, the Federal Reserve chair, said at a news conference last week that assuming the impact would be temporary is more challenging now because inflation has been above the Fed’s 2% target for five years, souring sentiment about the economy among many Americans.

For now, many Fed officials are focused on the threat of higher inflation and have signaled they are likely to keep the key rate unchanged in the coming months. Economists at UBS, according to AP, expect inflation based on the Fed’s preferred measure to jump to 3.4% this month and end the year at 3%, above the Fed’s 2% target, while Goolsbee said the unemployment rate is “kind of low and stable” and not as far from the target as inflation.

As investors anticipate a higher-rate path for longer, longer-term benchmark yields have risen. The yield on the 10-year Treasury note has moved up from just below 4% on Feb. 27—before the Iran war began—to nearly 4.4% on Wednesday, and mortgage rates tend to follow the direction of those longer-term yields.

Mortgage rates have climbed accordingly. Mortgage giant Freddie Mac reported that 30-year fixed-rate mortgages are averaging 6.22%, up from just below 6% before the war, and the verified vintage value for that indicator on this article’s date is 6.22% (FRED series MORTGAGE30US).