Changing our Fed call: Cuts delayed but not denied

The primary and most immediate transmission of the Iran war is higher energy prices. This energy shock will likely boost headline inflation and, to a lesser extent, core inflation. We anticipate a disruption to oil production and transit through the Strait of Hormuz for two months from the start of the conflict , with oil prices subsiding thereafter. We also en vision slowing consumer sentiment, eroded spending power , and weaker employment and as such are decreasing our expectation for growth this year. This elevated near-term path for inflation will make it difficult for the Fed to reduce its policy rate when we previously anticipated and we are therefore pushing back the next cut in our Fed forecast from June to July, followed by a second cut in October. Should the labor market and economic activity weaken more substantially than we expect, we do not think concerns about the transitory impact on inflation from higher energy prices will prevent earlier cuts – so long as longer-run inflation expectations remain well-anchored. On the contrary, economic resilience could further delay or eliminate cuts. For the time being, the Fed will be content to wait and observe the impact from the war, and like the rest of us continue to follow the ever-changing narrative about its ultimate duration.