Unlike the projections coming from Australian analysts about what the Reserve Bank of Australia (RBA) will do with interest rates, the US Federal Reserve is widely expected to leave interest rates unchanged at 3.50% to 3.75% at its upcoming meeting, but the prolonged conflict with Iran and increasingly hawkish signals from policymakers have made the decision less straightforward than it appeared only weeks ago.
Kish Pathak, fixed income research analyst, and Erik Weisman, chief economist and portfolio manager, said the resumption of hostilities had reduced the relevance of recent softer inflation data and increased the risk that the Federal Open Market Committee could consider further policy tightening.
Oil shock raises second-round inflation risks
The Fed has repeatedly warned that an extended period of elevated inflation, regardless of its initial cause, could lead to inflation expectations becoming less firmly anchored.
The conflict with Iran has lasted substantially longer than many geopolitical analysts anticipated when hostilities began in March, keeping energy prices elevated and increasing the risk that higher fuel and transport costs spread more broadly through the economy.
Should the conflict remain unresolved by the time of the FOMC meeting, hawkish members may be able to make a credible case for an interest rate rise.
A prolonged oil-price shock would also increase the likelihood that inflation remains persistent, strengthening arguments in favour of tighter monetary policy.
Warsh maintains focus on inflation control
Federal Reserve chair Kevin Warsh adopted a slightly more hawkish tone during recent testimony before Congress.
While he played down the near-term inflationary effects of artificial intelligence adoption, Warsh reiterated that maintaining price stability remained the central bank’s primary objective.
He also cautioned against interpreting the favourable June inflation reading as evidence that the Fed’s work was complete, suggesting policymakers would require more sustained progress before becoming confident that inflation was under control.
Fed commentary shifts hawkish
Public comments from Federal Reserve officials have been hawkish overall since the June meeting.
Governors Christopher Waller and Lisa Cook both indicated that rate increases could be appropriate in the near term should inflation fail to ease.
Waller’s comments were particularly notable because he has historically been viewed as one of the more dovish members of the FOMC.
Minutes from the June meeting also showed policymakers were assessing several economic scenarios. Should inflation remain elevated, support for additional rate rises is likely to strengthen.
Press conference adds to speculation
Warsh’s decision to hold a press conference following the meeting has also attracted attention and may indicate that policymakers expect the meeting to carry greater significance.
Warsh previously suggested he could skip post-meeting briefings when there was little of consequence to communicate.
The decision to proceed with a press conference could therefore be interpreted as a signal that the Fed is preparing to deliver a more hawkish message in response to the worsening geopolitical and inflation outlook.
An alternative explanation is that Warsh intends to maintain the existing communications schedule until the Fed’s communications taskforce completes its review.
Although an unchanged rate decision remains the most likely outcome, prolonged conflict in the Middle East, elevated energy prices and stronger inflation concerns have narrowed the gap between holding rates steady and resuming policy tightening.