The Federal Reserve is confronting a familiar — and increasingly uncomfortable — pattern: just as inflation appears be easing, another shock emerges to keep it elevated, The Wall Street Journal reports.

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Vincent Reinhart, a former senior Fed adviser now at BNY Investments, sums up tomorrow’s interest rate decision well: “The Fed is leaning toward policy ease. That’s the big picture. But they’re not going to cut rates until they’re sure inflation is durably lower.”

That predicament has sharpened into something more acute: policymakers must now weigh not just when to cut rates, but whether they can credibly signal any cuts at all as the economy absorbs the fallout from America’s war in the Middle East.

The risk spectrum has widened — recession, persistent inflation, or even stagflation — depending on how the conflict evolves and how the economy responds.

At the same time, inflation is moving in the wrong direction. The Fed’s preferred gauge, core personal-consumption expenditures prices, rose to 3.1% in January, up from 2.6% last April, underscoring stalled progress.

That stickiness is colliding with signs of economic weakness. Employers added just 10,000 jobs per month last year, down sharply from 377,000 per month in 2022. Delinquencies are rising, and savings for the bottom 80% of households have eroded significantly.

5 Years of Inflation — and Counting

In 2021, Federal Reserve Chair Jerome Powell characterized rising prices as “transitory,” expecting inflation to fade without aggressive tightening.

For the fifth straight year, Fed officials have expected inflation to fall back to target, only to be thwarted by a new disruption.

First came the pandemic’s aftershocks. Then Russia’s invasion of Ukraine. Last year brought sweeping tariffs.

A crackdown on illegal immigration has tightened labor supply.

Now, a new geopolitical shock with the war in Iran threatens global shipping and energy markets.

The latest conflict risks triggering an oil shock, pushing up energy and commodity prices and further delaying progress toward the Fed’s 2% goal.

Officials meeting this week are no longer debating when rate cuts will begin. The more pressing question is whether the outlook allows for cuts at all.

The war is expected to reinforce consensus around holding rates steady in the near term.

Beyond that, investors are staying tuned to three key Fed signals from its meeting tomorrow.

• The policy statement: Some officials want to drop language suggesting the next move is a cut—an acknowledgment the easing cycle may be over.
• Quarterly projections: All 19 participants will update their forecasts for inflation and interest rates.
• Powell’s press conference: Fed Chairman Powell will shape how markets interpret both.

The Fed’s job has become more fraught as geopolitical risks cloud the outlook.

When tariffs were rolled out last year, Powell emphasized patience — using “wait and see” 11 times in one press conference. A similar stance now appears inevitable.

The war has made forecasting more difficult by expanding the range of plausible outcomes.

Oil prices could fall if the conflict is contained — or surge if it escalates — raising the risk of both higher inflation and weaker growth.

“The people that were more worried about inflation before are going to be even more worried about it now,” said Jonathan Pingle, chief U.S. economist at UBS. “But the people that were more worried about the labor market — this should probably increase their concern, not lessen it.”

Traditionally, central banks look through oil shocks, assuming inflation and growth effects offset. But that approach depends on public confidence that inflation will fall — confidence that has been eroded after years of elevated prices.

“Do we really want to do another ‘Transitory 2.0’?” said Minneapolis Fed President Neel Kashkari.

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Policy Paralysis

Complicating matters further, the economy is being hit by overlapping shocks that are difficult to disentangle.

Tariffs, energy prices, and immigration policy are all influencing inflation and employment simultaneously. However, the unemployment rate has barely risen despite weak job growth, reflecting constrained labor supply.

The inability to isolate these effects “makes it very difficult for the Fed to be particularly decisive,” said Eric Rosengren, former Boston Fed president.

That indecision is showing up in rate projections.

In December, most officials expected at least one cut this year. Now, only a small shift in views could eliminate that expectation entirely — signaling a prolonged pause.

Jim Bullard, former St. Louis Fed president, said he would now abandon expectations for cuts altogether. With inflation above 3%, “you wouldn’t want to be committing to cuts here.”

Investors have begun recalibrating rapidly.

Markets now see just a 47% chance of at least one rate cut by December, down from 74% before the Iran conflict escalated. Meanwhile, the probability of a rate hike has jumped to 35% from 8%, according to Atlanta Fed calculations.

A More Fragile Backdrop

Today’s economy also looks far weaker than during the last major commodity shock.

Unlike 2022, when strong hiring and excess savings cushioned households, today’s environment features sluggish job growth and diminished financial buffers. That makes the economy more vulnerable to an oil shock.

Pingle compared the situation to 1990, when a Persian Gulf oil shock tipped the U.S. into recession.

For much of the past two years, the Fed could cut rates preemptively when labor markets softened, confident inflation was on track to decline.

That strategy is now at risk of breaking down.

If inflation forecasts rise toward 3%, it becomes harder to justify cutting rates — especially if current policy is no longer clearly restrictive. At the same time, signs of economic weakness argue for keeping cuts on the table.

The result is a narrowing path forward.

As Pingle put it: “This is a point where they might have to wait and react to the weakness that might unfold.”