By Howard Schneider
WASHINGTON, March 12 (Reuters) - Chances for President Donald Trump's Federal Reserve chair nominee Kevin Warsh to quickly loosen monetary policy are dwindling in the eyes of investors and analysts who have begun pushing back the dates of expected rate cuts and limiting how far they see Warsh being able to steer his colleagues towards lower borrowing costs if an ongoing oil price shock persists.
Despite moves by major developed nations to release stockpiled oil reserves, the price
of benchmark Brent Crude surged back to more than $100 a barrel on Thursday amid ongoing Iranian attacks against shipping in the strategic Strait of Hormuz, more oil infrastructure closures in the region, and Trump's rhetoric that has veered from hints of a quick end to U.S.-Israeli bombardment of Iran to demands for "unconditional surrender" from the country's ruling Islamist regime.
The war has been a blow to Trump's efforts to focus on pocketbook issues, with the price of gasoline jumping to nearly $3.60 a gallon on Thursday from less than $3 before the start of hostilities. Interest rates on 30-year home mortgages this week rose to 6.11% from 6% last week according to housing agency Freddie Mac, and interest rates on a variety of U.S. government debt have also jumped since the start of U.S.-Israeli bombing in Iran, a challenge if sustained to Trump's pledges to curb U.S. deficits. Stock markets are also sharply lower, possibly undercutting a key prop to consumer spending among wealthier households.
Central bankers typically regard commodity supply shocks as leading to temporary price disruptions with only a fleeting impact on underlying inflation. But the longer oil prices remain elevated, the more it feeds through to top-line consumer items like gasoline as well as to the diesel fuel that powers the trucking industry, and eventually to things like airline ticket prices and even food given the potential for fertilizer prices to rise.
With inflation already above the Fed's 2% target and memories of the pandemic-era inflation shock still fresh, policymakers remain concerned that their credibility is at stake, and that relenting on interest rates if prices escalate would send the wrong message.
The Fed's response will "depend on the scale, scope, and length" of the oil shock, said Vincent Reinhart, chief economist at BNY Investments, who noted that rising energy costs get spread through the economy in complex ways, increasing some prices but also leading consumers to shift or slow spending, and changing expectations for economic growth and hiring. The current Fed has the added complication that public attitudes about inflation may be primed to shift given the experience of the last five years when inflation soared to levels not seen since the 1980s - during a different U.S. conflict with Iran.
"If expectations are less well anchored, it'll show up more in inflation," than as a blow to growth, Reinhart said. Though he believes the Fed is still leaning towards rate cuts, "this is a situation in which uncertainty is elevated and the appropriate policy is to sit and wait to see what happens."
Fed officials are in fact expected to hold the policy rate of interest steady in the current 3.5% to 3.75% at their meeting next week, with attention more on the language of a new policy statement, the more detailed outlook provided by Fed Chair Jerome Powell in a press conference, and new economic projections that will show policymakers' initial assessments about the impact of the war on prices, jobs, growth and interest rates.
Officials will be hard-pressed to read the tea leaves in the current muddled brew they are trying to understand, with the Iran war front of mind but important unsettled questions also around tariff policy, immigration, and recent regulatory and tax changes that could influence businesses and households.
Government data only arrives with a lag, and it may even take time for shifts in behavior to show up in higher frequency sources.
Michael Gunther, senior vice president for research and market intelligence at Consumer Edge, a firm that aggregates spending data from credit and debit cards, said that since the war began there were some possible signs of consumers adjusting to higher gas prices by ordering more from online retailers, and boosting per-trip spending at some stores perhaps as a way to space out the need to drive.
But "in terms of meaningful drop-offs in spending since Saturday, the 28th of February -- we are not seeing it," Gunther said. As oil prices add to inflation worries, investors see the Warsh Fed increasingly constrained. Expectations that the new Fed chair would usher in his term with a rate cut at his first meeting in June have now shifted steadily back, perhaps as late as December. Data from the CME Group's FedWatch indicate a long wait from there, with the next cut not coming until late in 2027.
Warsh must still be confirmed by the Senate before an anticipated handoff from Powell in May.
EY Parthenon chief economist Gregory Daco said he now does not expect the Fed to cut until December, and "it is entirely plausible that the Fed won’t deliver any rate cuts this year," putting Warsh quickly out of step with Trump's ongoing demands, repeated on Thursday for immediate and deep rate cuts.
New data on the Fed's preferred Personal Consumption Expenditures Index will be released today for the month of January, with analysts expecting it has remained at least a percentage point above the Fed's target - a number that itself is already out of date given the lag in reporting and the onset of U.S. hostilities with Iran that won't begin filtering into official statistics for weeks. Economists polled by Reuters expect PCE inflation accelerated to a 3.1% annual rate in January from 3% the month before - but that's excluding volatile energy and food items that could be about to drive headline inflation higher and trigger debate over just how fully the Fed can "look through" the fallout from the war with Iran.
The most recent jobs data showed firms shed 92,000 jobs in February, an unexpected slide that highlighted concerns about labor market weakness.
The public's mood about inflation will also be updated on Friday with new data from the University of Michigan consumer survey, which often reflects jumps in inflation expectations when gas prices rise.
Luke Tilley, chief economist at Wilmington Trust, said the Fed is likely to strike a somewhat hawkish tone still at the upcoming meeting, given the concerns about inflation expectations, but to also acknowledge risks to growth that he feels will eventually lead to a series of rate cuts this year.
Job growth, for example, remains concentrated in a single sector, health care, and "we've never had a time where we were losing this many jobs outside of health care, that we didn't go into recession," Tilley said. "I don't see us at a really solid place to be managing an energy price cycle like this right now."
(Reporting by Howard Schneider; Editing by Anna Driver)
