Fed officials are growing anxious about the Iran war

Washington (CNN) — Tension is building among the policymakers tasked with wrangling inflation as the economic effects of the US-Israeli war with Iran broaden.

When Federal Reserve officials convened on March 17-18, just a few weeks after the war broke out, Chair Jerome Powell said any effects on inflation would likely be temporary and could be contained within the energy industry, keeping the door open for at least one rate cut this year. At the time, Wall Street was also optimistic that Kevin Warsh, President Donald Trump’s pick to succeed Powell, would push for rate cuts, if he’s confirmed.

But the Iran war has dragged on since then, and is now in its tenth week. At the latest Fed meeting in late April, officials’ anxieties became much more apparent. Three officials dissented from the Fed’s latest policy statement, disagreeing with its “easing bias,” or the suggestion that rates may go lower.

Those officials — Fed presidents Beth Hammack of Cleveland, Lorie Logan of Dallas and Neel Kashkari of Minneapolis — said in statements detailing their dissents that the Fed is not being forthcoming about the growing chances of a rate hike. And they’re likely not the only ones within the Fed’s 19-person rate-setting committee with those concerns, according to experts, since only 12 of them have voting power at a time.

“The opposition against the easing bias was likely broader than just those three,” said Derek Tang, an economist at Monetary Policy Analytics. “But the question is, when will the dam break on inflation expectations? Inflation has been above their 2% target for a while now.”

Snarled supply chains

It’s not just oil: The Iran war has made it difficult for businesses to access various other key commodities, such as fertilizer, helium and aluminum, in turn pushing up their prices.

That’s leaving businesses across industries scrambling to reconfigure their supply chains and come up with strategies to offset the disruptions, according to the latest business surveys from the Institute for Supply Management. For example, in ISM’s April survey, released Tuesday, a utility company said it is “mitigating risk through early procurement, supplier diversification and strategic inventory positioning.”

The Federal Reserve Bank of New York’s Global Supply Chain Pressure Index shot up in April to a reading of 1.82, up from March’s 0.68 and the highest level since 2022.

“This echoes the severe shortages and supply disruptions that the world economy experienced in 2021 as it emerged from the pandemic,” New York Fed President John Williams said Tuesday at an event in New York.

Logan, who is a Fed voter this year, echoed that concern in a statement detailing her policy dissent last week, adding it could exacerbate inflation: “The conflict in the Middle East raises the prospect of prolonged or repeated supply disruptions that could create further inflationary pressures.”

Inflation expectations

In March, Powell said Americans’ perception of prices will shape the Fed’s response to the Iran.

The Fed always pays close attention to inflation expectations, particularly over the long term, because they can be self-fulfilling. If people expect inflation to remain elevated in the comings years, then they’ll adjust their spending accordingly. It’s also a key gauge of confidence in the Fed’s ability to rein in price pressures.

Williams in his Tuesday speech said inflation expectations remain “well anchored, despite the deluge of shocks.” Key surveys from the University of Michigan, the New York Fed and the Conference Board show that to be the case. Kashkari, one of the dissenters at last month’s Fed meeting, agreed in a statement on Friday, writing he’s “somewhat comforted by the fact that both market and survey measures of long-run inflation expectations appeared well anchored at our 2 percent target.”

But just on Tuesday, a market-based measure of long-term inflation expectations climbed to a three-year high. The 10-year inflation breakeven rate, which is the difference between the 10-year Treasury yield and the 10-year Treasury Inflation-Protected Security yield, reached 2.5%, the highest level since early 2023.

“The longer inflation remains above 2%, the greater the risk that it becomes entrenched in expectations, making it harder to achieve the (Fed’s) goal,” Fed Vice Chair Philip Jefferson warned in March, shortly after the Iran war broke out.

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