Federal Reserve Governor Christopher Waller said Friday that the war in the Middle East is likely to push inflation higher in the near term and complicate the path for monetary policymakers. He added that a rapid de-escalation, however, would keep open the possibility of cutting interest rates later this year.
Addressing an audience at Auburn University, Waller cautioned that persistent pressure on energy markets and constraints on shipping routes could lead to broader, more durable price pressures. "The longer energy prices remain elevated and the Strait is constrained, the greater the chances that higher inflation gets embedded across a wide variety of goods and services, various supply chain effects start to emerge, and real activity and employment start to slow," he said in prepared remarks.
Waller framed his policy calculus as a balancing act between the Fed's dual mandate of price stability and maximum employment. "If high inflation and weak hiring came to define the economy, I'll have to balance the risks to the two sides of the Fed's dual mandate to determine the appropriate path of policy, and that may mean maintaining the policy rate at the current target range if the risks to inflation outweigh those to the labor market," he said.
At the same time, the governor sketched an alternative path. If the conflict were to end quickly, he said underlying inflation could continue toward the Fed's 2% objective and that would leave him "cautious about rate cuts now and more inclined toward cuts to support the labor market later this year when the outlook is more steady."
Waller underscored the elevated level of uncertainty facing policymakers and observed that it is becoming harder to treat shocks as purely transitory. He warned that a succession of shocks requires heightened vigilance. "With a sequence of shocks, policymakers need to be more vigilant," Waller said, adding "this is because if the shocks hit one after another, they will keep inflation elevated for quite some time."
In assessing the near-term data, Waller said he expects the overall personal consumption expenditures price index to reach 3.5% in March, a rate well above the Fed's 2% target. He also noted a shift in labor market dynamics: changes mean the level of job creation required to hold the unemployment rate steady now stands at around zero, implying that monthly job losses do not automatically indicate the onset of a recession.
Waller's comments are likely to be the last substantive public remarks from Federal Reserve officials before a scheduled blackout period ahead of the Federal Open Market Committee meeting on April 28-29. At that gathering, officials are widely expected to keep the current policy rate target in the 3.5% to 3.75% range while they continue to monitor the economic fallout from the Middle East conflict.
His remarks followed similar caution from other central bankers. New York Federal Reserve President John Williams said on Thursday he expects overall inflation to run "well above" 3% for a few months and warned that, given the level of uncertainty, "it's not a time to try to give...strong forward guidance" about the path of interest rates.
Geopolitical developments over the past day included a statement from Iran that the Strait of Hormuz is "completely open" for transit amid an ongoing ceasefire, while a separate statement from former U.S. President Donald Trump said the United States would maintain its blockade of Iran's ports. Markets reacted: oil prices fell and stock indexes rallied as investors increased the odds that the Fed might cut its policy rate by year-end.
Waller's remarks highlight the dilemma facing monetary authorities: how to respond to inflationary pressure stemming from external shocks without prematurely tightening or loosening policy in ways that could harm employment or price stability. The near-term readings on inflation and the evolving situation in key shipping lanes will be central to the Fed's deliberations between now and the April policy meeting.
Summary
Federal Reserve Governor Christopher Waller warned that the Middle East war is likely to raise inflation in the short run and complicate decisions on interest-rate cuts. He said prolonged energy-price elevation and shipping constraints could entrench inflation and weaken real activity and employment, while a quick resolution would keep open the option of rate cuts later this year.
Key points
- Waller expects the PCE price index to reach about 3.5% in March, above the Fed's 2% target.
- Persistent energy-price pressure and constraints at the Strait could embed inflation across goods and services and prompt supply-chain effects.
- Waller said the job creation level needed to keep unemployment steady is around zero, so single-month job losses do not necessarily indicate a recession.
Sectors most impacted
- Energy - price movements and supply disruptions influence inflation and market volatility.
- Financial markets - expectations for Fed rate moves affect stocks and bond yields.
- Labor - hiring dynamics determine how the Fed balances employment against inflation risks.
Risks and uncertainties
- Prolonged elevated energy prices and constrained shipping could embed higher inflation, affecting consumer prices across many goods and services.
- A sequence of shocks may keep inflation elevated for an extended period, reducing the Fed's ability to treat shocks as temporary.
- Geopolitical developments around the Strait of Hormuz and differing state actions create uncertainty for oil markets and policy responses.
Tags: Fed, inflation, energy, labor, rates