Investors face cloudier Fed rate view as Iran war grips markets

NEW YORK – Investors are facing a cloudier view of US interest-rate direction in the coming months, with a war in the Middle East muddying the outlook for a Federal Reserve that was already grappling with above-target inflation and an uneven labour market.

The Fed on March 18 held rates steady for the second consecutive meeting, as markets had expected, and stuck to its prior projections for one cut in 2026. But the US central bank also forecast higher inflation in 2026 than it had previously, amid the surge in oil prices stemming from the conflict in Iran, while Fed chairman Jerome Powell said it was too soon to know the ultimate fallout for the economy.

Investors who were banking on near-term rate cuts were reconsidering. Amid the Middle East turmoil, some were left eyeing places to hide, including long-dated bonds, commodities or dividend-paying equities.

“The market is trapped amid a whole lot of reasons to be nervous, a lot of reasons to be uncertain, including what is happening at the Fed,” said Mr Mark Spindel, chief investment officer at Potomac River Capital.

US stocks sold off following the Fed meeting, with the benchmark S&P 500 sinking 1.4 per cent on the day.

Asian markets followed in the red as they also digested a fresh jump in oil prices, with Brent crude rising above US$112 a barrel, as Iran’s huge Pars gas field was hit on March 18 in a major escalation of the war.

Dimming rate cut hopes

The nearly 50 per cent surge in crude prices since the conflict began on Feb 28 and the extent to which it will force the Fed to dial back rate cuts have been top of mind for investors.

Even as the Fed maintained its rate projection on March 19, markets reduced their expectations for monetary easing following the meeting. Mr Powell noted that individual Fed member projections show a “meaningful” number of policymakers are pencilling in less easing in 2026 than they did three months ago.

Mr Powell “pointed not only to high energy prices, but tariffs too... he’s really now on the lookout for inflation”, said Mr Jack Ablin, chief investment officer at Cresset Capital. “I’m sure there’s going to be a growing school of thought that says they won’t cut at all this year.”

Fed funds futures suggested investors expected only about 14 basis points of easing by December, according to LSEG data, or barely half a standard quarter-percentage-point cut. That is down from at least two such cuts expected as at late February before the US-Israeli military strike on Iran began.

A weakening jobs backdrop had prompted the Fed – which seeks to maintain stability in employment and inflation – to lower its benchmark rate in 2025 to its current level of 3.5 per cent to 3.75 per cent.

“From an overall perspective, it kind of highlights the delicate balance,” said Mr Brent Schutte, chief investment officer at Northwestern Mutual Wealth Management Company, who said his firm is underweight in equities. “We’ve made no progress on inflation, but the jobs market is still weak and is actually showing signs of being weaker.”

Will Powell stay on?

This week’s meeting was expected to be Mr Powell’s second-to-last as chairman, with his term as the central bank’s head expiring in May. President Donald Trump, who has castigated Mr Powell for not lowering rates more, has nominated Mr Kevin Warsh, a former Fed governor, to replace Mr Powell.

But Mr Powell on March 18 said he will stick around as head of the central bank until his successor is confirmed, and will not leave the institution until a criminal investigation into the Fed is resolved.

Mr John Velis, Americas macro strategist at BNY, said Mr Powell’s remarks that he may remain on the Fed board after the investigation, combined with uncertainty over how long inflation will persist and when rate cuts might resume, pushed yields higher.

With Mr Powell still on the Fed board, “Warsh (is) less likely to come on board quickly and lower rates”, Mr Velis said.

As investors position for the changing backdrop, Mr Ablin said stocks that pay a consistent and growing dividend “could be a good place to hide while these issues sort themselves out”.

Mr Phil Blancato, chief market strategist at Osaic, said he favours adding commodities, given firm inflation, but he was less upbeat about US equities.

“You’re going to have no choice but to think about where you can diversify away from US stocks because ultimately, the Fed’s not coming to rescue the market here,” he added. REUTERS