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(Bloomberg) — The Federal Reserve would probably discount the effects of the Iran war on prices if policymakers decide raising interest rates becomes necessary this year, according to Morgan Stanley’s global head of fixed income research.
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“Our thinking is that the Fed would look through that,” Andrew Sheets said Thursday on Bloomberg Television’s Surveillance. “The Fed would see that as more of a growth shock than an inflationary shock. And so that’s probably not the factor that we think would move the Fed towards hiking.”
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Rising costs have prompted some Fed officials to say hikes may be needed in 2026 to help stem inflationary pressures. Traders now see about a two-thirds chance the Fed will tighten policy by year-end, after having predicted more than two cuts just before the war began. Global energy prices have soared since Iran shut off the Strait of Hormuz, which handled about a fifth of global oil and gas flows before the war.
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Measures of core inflation are “well over the Fed’s target,” Sheets said.
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“Coming into the second half of the year, there’s, I think, a justifiable concern that the Fed is succeeding on the jobs side of the mandate, but not succeeding on the inflation side,” he said.
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But, he added, the war may not be the cause. Instead, the drivers may be a mix of easy fiscal policy, increasing bank loan growth and spending on artificial intelligence, although Sheets said that Morgan Stanley expects the inflation picture to improve during the second half.
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“We think inflation does come down,” he said. The labor market will remain choppy “with enough uncertainty to keep the Fed on hold this year and then opening up the potential — in our case, the base case — for some cuts next year.”
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Still, policymarkers are getting worried. Dallas Fed President Lorie Logan, a voting member of the Federal Open Market Committee this year, said Wednesday that while the US labor market is “broadly balanced,” inflation doesn’t appear to be headed back to the Fed’s 2% goal.
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“I am increasingly concerned that higher interest rates could be necessary later this year to fully restore price stability and appropriately balance both sides of the Fed’s dual mandate,” Logan said at an event in El Paso, Texas.
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(This story was produced with the assistance of Bloomberg Automation.)
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—With assistance from Annmarie Hordern.
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English (US)