Federal Reserve Holds Rates Steady Amid Surge in Oil Prices and Middle East Conflict

Oil prices are surging, war has closed one of the world’s most important shipping lanes, and the White House is demanding cheaper money. The Federal Reserve’s answer, for now, is to stand still.

At its March 17–18 meeting, the Fed left its benchmark federal funds rate unchanged in a range of 3.5% to 3.75% and projected just one quarter‑point rate cut this year, even as its own forecasts show inflation running hotter and risks to growth mounting.

The new Summary of Economic Projections, released March 18 alongside the policy statement, offers the central bank’s first detailed look at how it thinks the U.S. economy will absorb the economic shock from the war in Iran and the effective shutdown of the Strait of Hormuz, a chokepoint for roughly one‑fifth of global oil shipments.

“Economic activity has been expanding at a solid pace,” the Federal Open Market Committee said in its statement. “Job gains have remained low, and the unemployment rate has been little changed in recent months. Inflation remains somewhat elevated.”

Higher inflation, sturdier growth — and more uncertainty

The Fed’s latest projections show a slightly stronger economy than officials anticipated three months ago, but also more persistent inflation.

Policymakers now expect inflation, as measured by the personal consumption expenditures price index, to climb 2.7% in 2026 on a fourth‑quarter‑over‑fourth‑quarter basis, up from 2.4% in December’s forecast. Core PCE inflation, which strips out food and energy and is closely watched inside the Fed, is also seen at 2.7% next year, compared with 2.5% previously.

Officials still anticipate inflation returning to the Fed’s 2% goal, but not until 2028.

At the same time, the central bank nudged up its outlook for real gross domestic product. It now sees inflation‑adjusted GDP growing 2.4% in 2026, versus 2.3% in December, with slightly faster growth penciled in for 2027 and 2028 and a higher estimate of the economy’s long‑run potential.

The unemployment rate is projected to hover around 4.4% at the end of 2026, roughly where it stands now, before edging down to 4.2% in the longer run. That is modestly higher than the pre‑pandemic lows but consistent, officials say, with a labor market that is no longer overheated.

Behind those median numbers, however, the Fed’s own assessment of risks has darkened. A large majority of policymakers judge that the risks to GDP growth are tilted to the downside and that unemployment is more likely to run higher than their baseline forecast than lower. On inflation, the tilt runs the other way: most officials see greater odds that price increases will exceed their projections than fall short.

That combination—downside risks to growth and upside risks to inflation—is reminiscent of the stagflation fears that shadowed earlier oil shocks, though neither the statement nor Chair Jerome Powell used that term.

“Nobody knows how large or persistent the effects on the U.S. economy will be,” Powell said at his post‑meeting news conference, referring to the Iran conflict and the disruption in the Strait of Hormuz.

Oil, tariffs and a new inflation shock

The war’s economic impact has been felt first and most visibly at the pump. Since late February, when U.S. and Israeli strikes on Iran escalated into a wider conflict and tankers began avoiding Hormuz, global benchmark Brent crude has climbed from roughly $73 a barrel to peaks above $110 and, at times, $120.

Powell said recent inflation readings “largely reflect inflation in the goods sector,” which has been “boosted by the effects of tariffs” and now by higher energy costs. Fed staff estimate that total PCE prices rose about 2.8% over the 12 months through February, with core PCE around 3%.

For years, central bankers have often tried to “look through” temporary spikes in energy prices on the theory that they reverse on their own. Powell suggested that history is a less reliable guide after the United States has already endured several years of above‑target inflation.

“The decision to look through increases in energy prices is not one we will take lightly,” he said, noting the backdrop of elevated goods inflation and recent tariff policies.

The Fed’s statement explicitly flagged the Middle East conflict as a source of uncertainty, saying, “The implications of developments in the Middle East for the U.S. economy are uncertain.”

One cut on the horizon — and a more hawkish tilt inside

Despite raising their inflation forecasts, policymakers did not shift their median outlook for interest rates this year. The Fed’s so‑called dot plot, which shows each official’s preferred path for the federal funds rate, still points to a midpoint of about 3.4% at the end of 2026, implying one 25‑basis‑point cut from current levels.

The median projection shows another small cut in 2027 and then a plateau around 3.1% in 2028, which officials also now view as the long‑run neutral rate—the level that neither stimulates nor restrains the economy. That longer‑run estimate is up slightly from 3.0% in December, suggesting officials think the era of ultra‑low interest rates that followed the 2008 financial crisis has given way to a higher‑rate equilibrium.

Powell acknowledged that the stability in the medians masks a subtle but important shift in sentiment.

“Four or five participants moved from seeing two cuts this year to just one,” he told reporters. In other words, while the center of the committee still expects a single reduction in borrowing costs in 2026, fewer policymakers are pushing for a more aggressive easing cycle.

The March decision to hold rates was backed by an 11–1 vote. The lone dissenter, Governor Stephen Miran, favored lowering the target range by a quarter point. Miran, a former chair of the Council of Economic Advisers during President Donald Trump’s current term, also dissented in January in favor of a cut.

The central bank has already reduced its benchmark rate by a total of 1.75 percentage points from the peak of 5.25% to 5.5% reached in mid‑2023 as it battled the worst inflation in four decades. Powell said current policy is now “roughly neutral,” neither clearly restraining nor boosting growth.

Political pressure and a looming transition

The Fed’s cautious stance comes amid intense political scrutiny. Trump has repeatedly criticized Powell for not cutting rates more rapidly and has publicly floated the idea that he could remove the Fed chair before Powell’s four‑year term expires in May 2026, a move that would likely spark a legal and institutional clash.

In January, Trump said he would nominate former Fed Governor Kevin Warsh as the next chair once Powell’s term ends. Warsh has been an outspoken critic of the Fed’s balance‑sheet expansion and is generally viewed as skeptical of keeping rates low for extended periods.

Miran’s dissent and the earlier call for deeper cuts from Governor Christopher Waller in January underscore the shifting internal dynamics of a central bank where Trump‑appointed governors now occupy several key seats.

Powell, whose term as a member of the Fed’s Board of Governors runs until 2028, has consistently defended the central bank’s independence and its dual mandate to promote maximum employment and stable prices.

“We are not and will not be guided by political considerations,” he said in January when asked about Trump’s criticism. “We will do what we think is best for the American people.”

Households and global spillovers

While the Fed’s preferred inflation gauge is projected to rise 2.7% next year, that figure masks sharper pressures on lower‑income households. Energy and food costs, which tend to jump during oil shocks and supply disruptions, make up a larger share of spending for poorer families than for wealthier ones.

Gasoline prices have already climbed in many parts of the United States since the Hormuz crisis began. Higher fuel and transportation costs often feed into grocery and rent bills over time, intensifying the squeeze.

On the jobs front, the Fed’s projections amount to an acceptance of an unemployment rate around the mid‑4% range for several years—higher than the 3.5% to 3.7% readings seen before the pandemic. Powell said job gains have “remained low,” and noted that slower growth in the labor force, partly due to lower immigration and participation, is one factor in the labor market’s downshift.

Housing remains a weak spot. Despite the Fed’s rate cuts since 2023, mortgage rates are still well above the levels of the 2010s, and home prices remain elevated. Powell described housing activity as “weak,” reflecting a combination of high borrowing costs and limited supply.

Abroad, the combination of higher energy prices and a Fed reluctant to cut rates quickly is straining energy‑importing economies, particularly in Europe and the developing world. Higher U.S. yields can draw capital out of emerging markets and raise their borrowing costs just as they are contending with pricier oil and gas imports.

A forecast with wide error bars

Fed officials caution that their projections are, at best, educated guesses. Historical data suggest there is only about a 70% chance that actual outcomes for growth, inflation and interest rates will fall within fairly wide bands around the medians. For short‑term interest rates, for example, the typical forecast error range grows to ±2 percentage points or more over a three‑year horizon.

In this projection round, most officials also explicitly marked the uncertainty around their forecasts as “higher than normal,” reflecting the unpredictable course of the Iran conflict and the global energy market.

That leaves the central bank trying to chart a path based on models that were built for more stable times.

The Fed’s current road map assumes that the oil shock will not unravel long‑term inflation expectations, that the economy can tolerate somewhat higher unemployment without a deep downturn and that modest, gradual rate cuts will be enough to keep growth on track. Whether that holds will depend less on the dots in a chart in Washington than on how events unfold in the Strait of Hormuz and in the political arena—variables that lie beyond the central bank’s control.