Fed's Powell pushes back on rate hike talk
CIO Daily Updates
From the studio
From the studio
Thought of the day
Thought of the day
Fed policy is “in a good place” to wait and assess the economic effects of the Iran conflict, according to comments from Fed Chair Jerome Powell. Speaking at Harvard on Monday, Powell said inflation expectations still “appear well anchored” and noted that policymakers typically look through supply shocks such as oil spikes. New York Fed President John Williams separately described Fed policy as “well positioned” for a potential situation in which higher energy prices lift near-term inflation while dampening activity.
This latest Fed commentary comes as investors weigh the risk of US rate hikes tied to war-driven inflation. Markets last week started to price in the potential for a Fed rate hike at its December meeting, though futures are now suggesting around 3bps of cuts at the final policy gathering of 2026. Brent crude has climbed roughly 55% in March and is trading near USD 113/bbl at the time of writing, with markets reacting to limited energy flows through the Strait of Hormuz. US gasoline prices have risen toward USD 4 per gallon, for the first time since 2022. In the past 24 hours, President Trump warned in a Truth Social post that if a deal is not reached and the Strait is not reopened, the US would target “all of their Electric Generating Plants, Oil Wells and Kharg Island,” highlighting the risk of escalatory strikes and damage to energy infrastructure. Markets are also digesting a Wall Street Journal report on Tuesday suggesting President Trump may be seeking an off-ramp, with reports he’s said he could seek to end the current military campaign even if the Strait remains only partially reopened.
For Fed policy, uncertainty around outcomes in the Strait has kept the debate shifting between pricing inflation risks and the potential for higher energy prices to slow economic growth. But we see reason to think the Fed's easing bias will be delayed but not replaced with a more hawkish cycle:
An oil shock alone is likely insufficient. Higher energy prices may push headline inflation up in the near term. But Powell has explicitly argued that monetary tightening is often the wrong response to a supply shock. “By the time the effects of a tightening in monetary policy take effect, the oil price shock is probably long gone, and you’re weighing on the economy at a time when it’s not appropriate," Powell said on Monday. "So the tendency is to look through any kind of supply shock,” he added. Powell also said inflation expectations remain well anchored, reducing the case for an immediate policy response. In our view, this supports the idea that the Fed will want evidence of broader and more persistent inflation pressure before changing course, particularly in a backdrop that looks very different from 2022, with slower growth, softer labor markets, and policy rates already much closer to neutral.
Cuts look delayed, not gone. Powell’s remarks, alongside Williams’s emphasis on uncertainty, suggest the Fed remains in wait-and-see mode rather than on the verge of a move. At the same time, policymakers have reason to be cautious. Inflation is still above target, and the Fed will need to see evidence that core inflation is declining as the impact of higher US tariffs fades. Higher energy costs resulting from the Middle East conflict had added to uncertainty, and the Fed will want to ensure that this does not cause a renewed acceleration in core inflation. While this raises the bar for easing in the near term, and we now expect the first rate cut of the year in September rather than June, we still expect 50 basis points of rate reductions for 2026 overall.
Higher yields rebuild the high grade bond case. Recent moves in Treasuries show how quickly markets can shift from fearing inflation to worrying about a growth hit. We think markets have priced in too much tightening from top central banks in recent weeks. The rise in benchmark government bond yields in USD, EUR, and GBP has improved starting income, while current market pricing still looks too hawkish relative to our view that the Fed remains on a medium-term easing path. Against this backdrop, we see an attractive risk-reward profile for short-duration high-quality bonds. In a risk scenario where growth concerns intensify and financial conditions tighten further, higher-quality and longer-duration bonds should be better placed to perform.
So we do not believe the current energy shock will mark the start of a lasting Fed tightening cycle. Our base case is that the Fed will cut rates, albeit later this year than initially expected, with cash returns becoming less compelling as easing eventually resumes. Against that backdrop, we continue to favor diversified income and maintain an Attractive view on highly rated bonds, seeing the recent rise in government bond yields as an opportunity to lock in more attractive income and potential capital gains.
For investors seeking additional diversification, short-duration quality bonds and gold may also become more compelling if growth concerns begin to outweigh inflation fears. For those who do favor gold, a mid-single-digit allocation can help diversify portfolios and provide some protection from macro-related shocks. On the equity side of the portfolio, we continue to advise investors not to “trade” geopolitical events, but instead to stay invested while taking steps to progressively derisk portfolios the longer that oil prices remain high.