Middle East War Becomes the "Interest Rate Cut Dream" Killer? Fed's "Number Three": Current Policy Stance Is Just Right!

Ask AI · How William Williams, the Federal Reserve’s No. 3 official, balances economic risks from the war in the Middle East?

China Financial News Network (3/31) (Editor: Huang Junzhi) On Monday (3/30) local time, Federal Reserve Bank of New York President John Williams said that the current settings of monetary policy are conducive to addressing a series of challenges brought by the conflict in the Middle East—challenges that are likely to signal higher inflation in the near term.

That day, in a public speech, he said: “The current situation is indeed rare. But the current stance of monetary policy can balance well the risks to achieving our goals of maximum employment and price stability.”

Williams added that the Middle East war “could lead to a major supply shock, and its pronounced impact would simultaneously push inflation higher (through higher intermediate costs and surging goods prices) and restrain economic activity.”

“This situation has already started to show. Signs of disruptions in supply chains have also begun to appear,” he added.

Although the inflation outlook has “high” uncertainty, according to Williams, “developments in the Middle East have led to a sharp rise in energy prices, which could push overall inflation higher over the next few months. However, if oil prices fall after the conflict ends, some of these effects may be reversed later this year.”

This set of remarks appears to suggest that “doing nothing for now” is the best choice. As president of the New York Fed, Williams serves as the vice chair responsible for setting interest-rate policy at the Federal Open Market Committee (FOMC), and like the Fed’s governors, he has a permanent voting right. He is seen as the Fed’s “No. 3 figure.”

Uncertainty

The war jointly launched by the U.S. and Israel against Iran has brought significant challenges to the Fed, with the most direct economic impact showing up in a sharp surge in energy prices, because Iran has blocked shipping through the Strait of Hormuz.

High energy prices could push overall inflation higher. All else being equal, as long as they do not affect underlying price pressures and long-term inflation expectations, the Fed typically tends to look past it. In addition, rising energy prices may also put downward pressure on economic growth, because consumers’ energy spending would increase.

This puts the Fed in a difficult position and makes it harder for officials to send clear signals about the future direction of monetary policy. Earlier on Monday, Fed Chair Jerome Powell said the current economic situation calls for the central bank to remain cautious.

At an event in Cambridge, Massachusetts, Powell said: “We are dealing with the impact of the Middle East situation, and that will undoubtedly affect gasoline prices. We think the current policy is appropriate for us to wait and see. There are downside risks in the labor market, which suggests that interest rates should stay low; but there are also upside risks to inflation, which suggests that perhaps interest rates should not stay low.”

Financial markets are currently closely watching the likelihood of the Fed cutting rates further this year. Even though not long ago, given that inflation has been rising due to the war in a context where inflation is already above the Fed’s 2% target, investors were still weighing the prospect of rate hikes.

That day, Williams also said he expects economic growth of about 2.5% this year, inflation of 2.75%, and a decline back to the 2% target next year. He also said he expects unemployment to fall in both this year and next year.

Williams’s outlook on inflation and employment appears more optimistic than that of most of his Fed colleagues. They expect the unemployment rate to remain at the current 4.4% level through the end of the year and believe inflation will not reach the Fed’s 2% target until 2028.

(China Financial News Network Huang Junzhi)