"Hormuz Hold'em": FOMC Preview - The Fed's Playbook Is Hold or Cut, Not Hike

The FOMC is expected to leave rates unchanged at 3.50-3.75% in March. Money markets do not expect a rate cut before Q4 2026, although pricing may have been influenced by a rise in short-term yields following the recent energy price surge linked to the Iran war. Markets now fully price in one rate cut this year, compared with around two before the conflict. As Newsquawk notes, while some Fed officials have suggested they can look through one-off spikes, inflation is already well above the Fed's 2% target, which analysts say could constrain the Committee. The inflation upside comes amid renewed labor market pressure, even before the conflict. The February jobs report showed a -92k change in nonfarm payrolls, likely raising questions about stagflation at the post-meeting press conference. The Committee remains split between prioritizing the labor market and inflation sides of the mandate. Governor Waller has been vocal about labor market concerns, especially with AI now adversely impacting the job market at scale, which may guide his decision, while others remain focused on above-target inflation. Economists surveyed by Reuters expect the FOMC to cut rates in June, after Fed Chair Powell's term ends in May, despite disruption from the Middle East conflict, which has pushed up energy, metals and food crop prices. Separately, Senator Thom Tillis said the nomination of incoming Chair Kevin Warsh may remain before the Senate Banking Committee for some time due to his objections to advancing Fed nominees before the DoJ probe related to Powell concludes.

Morgan Stanley, which also expects the Fed to stay on hold in March as it debates the outlook (including the degree to which employment has stabilized, the risk higher oil prices pose for inflation and activity, and the appropriate path for monetary policy) expects the "dot plot" to continue to call for one rate cut this year and next, despite upward revisions to headline inflation from the recent rise in oil prices. This would be consistent with past practice of "looking through" oil-induced increases in headline inflation. Heading into the meeting, MS retains its outlook for two 25bps rate cuts this year in June and September. The main risk to the bank's outlook is that the median member pushes out rate normalization on account of inflation concerns; however that is unlikely "since it would run counter to past practice in dealing with oil price shocks and the softness in February employment." As such, the risk to monetary policy is asymmetric: rising oil prices amid above-target inflation is more likely to make the Fed delay cuts — or cut more when it does — than it will move to rate hikes.