The impact of developments in the Middle East on the U.S. economy remains highly uncertain but likely shifts the outlook for policy rates in a hawkish direction.
At the March FOMC meeting, the Federal Reserve kept the target range for the federal funds rate at 3.50-3.75% and maintained its outlook for one rate cut this year. For the second consecutive meeting, Governor Miran dissented in favor of a 0.25% cut. Both the statement and Chairman Powell’s press conference made mention that the impact of developments in the Middle East on the U.S. economy remains highly uncertain but likely shifts the outlook for policy rates in a hawkish direction. Indeed, since the conflict unfolded, the market has aggressively repriced expectations for rate cuts this year. At the end of February, markets were pricing in 2-3 cuts with the first full cut by July, now markets do not expect any easing at all this year.
Turning to the Summary of Economic Projections (SEP), updated committee forecasts supported a more hawkish policy stance:
- Growth was nudged higher by 0.1% to 2.4% this year, and by 0.3% to 2.3% in 2027, reflecting a more modest near-term boost to growth driven by OBBBA stimulus, yet more sustainable growth via productivity gains in 2027.
- Unemployment rate forecasts were unchanged.
- Both headline and core PCE forecasts were marked higher to 2.7% by 4Q26, before declining to 2.2% by the end of next year. Both tariff related inflation and, more recently, an energy price shock, are expected to keep inflation elevated this year, but normalize through 2027.
Altogether, we see a few key takeaways for investors:
- The updated “dot plot” showed the median interest rate outlook at one cut this year and next, indicating there is still an easing bias despite inflation risks.
- The Fed pushed up its longer-run estimate of the federal funds rate to 3.1% from 3.0%. This means that, all else equal, current policy is less restrictive than previously thought.
- Chairman Powell highlighted that the committee should look past short-term inflation shocks so long as they do not de-anchor longer run inflation expectations. Longer run inflation expectations have remained contained; however, they have moved modestly higher and are worth monitoring.
- Succinctly, Powell stated he would stay on as Chairman of the Federal Reserve until the investigation from the DOJ had concludes. In addition, if Kevin Warsh is not confirmed by the time his term expires in May, he will remain as Chair until the incoming Chair is confirmed.
Overall, we still expect the Fed to reduce rates at least once this year. Should the conflict in the Middle East subside in the coming weeks, oil prices will drop rapidly leading to a strong disinflationary impulse in the back half of the year, allowing the Fed to continue easing. The outlook remains highly uncertain; therefore, investors would be wise to remain diversified across domestic and international stocks, bonds, alternative assets and commodities.