While the ‘wait and see’ approach continues, the factors at play are seemingly becoming ever more complex as the geopolitical environment continues on its unpredictable course. Below, we address what we know, what we don’t know, and - most importantly - what we need to know.
The View in March
The data in mid-March showed the US economy to be stable, with consumer spending strong[1] despite continuing uncertainty in the labor market.[2] At the same time, inflation appeared to be creeping upwards, with January’s Core PCE reading (the Federal Reserve’s preferred gauge) rising to 3.1%.[3]
The Fed’s revised projections showed higher growth and inflation this year, as well as a higher neutral rate (3.1%).[4] However, as Chairman Jerome Powell also noted in the press briefing, “If [the Fed] were ever going to skip an SEP, this would be a good one, because we just don't know.”
Powell partly attributed the higher inflation reading to the ongoing tariff situation. However, the shadow of the conflict between the US and Iran, which began a few weeks prior on February 28th, also loomed large in the background.[5] The meeting minutes recently released show that a growing number of committee members are trending hawkish as progress stalls, implying that a rate hike could be on the table before long.[6]
In his press statement, Powell expressed the view that price shocks, which include both the effect of tariffs and oil supply constraints, are normally a temporary factor. He added that given that the US has seen above-target inflation for five years now, simply discounting them is inadvisable.[7]
The Story Continues
The impasse in which the Fed finds itself has been developing since last year. It consists of a combination of countervailing forces. A precarious labor market suggests that rates need to go down, while stubborn inflation makes the Fed wary of calling victory too early.
Data continues to emerge. The March employment figures (+178,000) appear to dramatically reverse the sudden drop in February (-133,000). However, the three-month average shows a more moderate increase of +68,333, which is comfortable enough to maintain employment stability.[8]
Core PCE came in at 3.0% for February, lower than January but still a full percentage point above target.[9] While the March headline CPI jumped from 2.4% to 3.3%, reflecting the spike in gas prices owing to the closure of the Straight of Hormuz, Core CPI showed a more modest increase of 2.5% to 2.6%.[10]
While many - including Powell - hope the impact of tariffs and the disruption of the oil supply will be temporary, it remains to be seen how ‘temporary’ the Iranian conflict will be. The Fed’s own models show that sustained upward pressure on the oil price could add to inflation substantially.[11]
Fed official Barkin pointed out in a recent speech that comparisons to the 1970s oil crisis are misjudged, given that the U.S. is now a net exporter of oil. However, inflation is as much a product of psychology as rational market forces.
Currently, the markets are pessimistic about the prospect of lower rates. While the Fed is still projecting one more cut this year, the market consensus for the next downward move is in mid-2027.
Conclusion
The current situation is an analytical nightmare. On the one hand, there is enough data to cherry-pick one’s way to any conclusion. On the other, there is enough instability to upend the most elaborate analyses in a matter of hours.
In such circumstances, it can be more helpful to narrow one’s focus. In the case of the Fed, the guiding light so far has been inflation. As long as Powell is at the tiller, it is likely this will remain the case.[12]
But broadening one’s focus is also important as well. Wider issues such as the impact of AI on productivity and the long-term sustainability of U.S. national debt remain the most important shaping forces for the economy and one’s investment portfolio. Finding the signal is a process of tuning out the noise.
[1] Bureau of Economic Analysis
[2] Bureau of Labor Statistics
[3] Bureau of Economic Analysis
[9] Bureau of Economic Analysis
