Does the Fed have a new inflation problem?

With inflation above target and the US economy softening, the Fed faced a difficult balancing act - even before the Iran war. But as soaring energy prices fuel inflation and growth concerns build, policymakers face an even greater dilemma as Fed frontman Jerome Powell prepares to vacate the chair next month.

17 March 2026

The US Federal Reserve (Fed) meets this week to decide on interest rates. To say that the backdrop is challenging would be an understatement. The US economy is showing signs of slowdown, with 92,000* jobs lost in the month of February, retail sales slowing and consumer confidence - according to the Michigan survey - not far off the 25-year low recorded after Russia invaded Ukraine. And all of those datapoints precede the war in Iran. At the same time, US headline inflation of 2.4%* for the month of February remains above the Fed’s official target of 2%. Given the Fed’s dual mandate of maximising employment and minimising inflation, things were already complicated before the Iran war, but they now threaten to become even more so.

Higher energy costs raise the stakes for the Fed

The obvious challenge would appear to be inflationary, with Brent crude futures as of Tuesday morning at USD 104 and the average US gasoline price now breaching the psychologically significant USD 4 mark at USD 4.38*. The negative effect on consumers will be pronounced if the situation continues - already inconvenienced by a partial US government shutdown resulting in huge airport security delays, expensive gasoline will serve only to dent confidence further and potentially slow the economy down. The dilemma for the Fed is stark – lower rates to support the economy or raise them to tackle potential further inflation. The futures markets feel that the Fed is already leaning towards the latter, with no changes to rates now priced in following the April Federal Open Market Committee (FOMC) meeting (current Chair Powell’s last), marking a tightening of the predicted policy stance in the last couple of weeks. But it’s worth considering the following: higher energy prices act as an income shock and, since it’s hard to cut down on energy, consumers have historically tended to cut down on other things instead during such periods. This often means that the goods which make up the core inflation basket see less demand during an energy crisis and therefore their prices don’t go up as much and headline inflation remains more anchored than investors anticipate.

The inflation story could yet have a twist

The Fed knows this too, with its FRB/US forecasting model¹ anticipating an outright decline in core inflation in the event of sustained oil price hikes. Hence even hawkish members are not talking about rate hikes as a baseline scenario at this point. Rate cuts being brought back on the table is therefore not beyond the realms of possibility, something the markets are barely expecting amid all the volatility. The end to the war with Iran would of course be the best news of all, but for volatile markets in search of any good news, a benign change in the interest rate outlook would certainly help.

Fewer rate cuts now anticipated, but could more still be possible?

From 1 Jan 2026 to 16 Mar 2026