USD: Fed reaction to Iran energy shock – ABN AMRO

ABN AMRO economists assess how Iran-driven energy shocks could alter Federal Reserve policy and thus the US Dollar. They see limited US growth impact but materially higher inflation, with the Fed likely delaying easing in a middle scenario, potentially hiking to 4.00% and holding longer in a negative scenario, while maintaining current cut plans in a positive case.

Fed path shifts with inflation scenarios

"The inflation impact is more substantial, particularly given existing price pressures. In our central scenario, energy inflation pushes up the headline rate to nearly four percent by the second quarter of this year. It remains persistently elevated throughout the year, but energy disinflation from high base effects pushes inflation down within reach of the 2% target in the second quarter of 2027. In the negative scenario, we expect inflation to peak at about 4.7% by the third quarter and to remain elevated for substantially longer."

"How would the Fed respond? In the middle scenario, inflation rises, but we judge it to stay within the ‘look-through’ range, although this will still prevent them from easing this year. The Fed may gradually resume easing at 25 bps per quarter from Q2-2027 onwards, still reaching our expected terminal rate of 3.00% by the end of 2027. In the negative scenario, inflation rises rapidly."

"While Powell is still in charge, he’ll try and succeed to get consensus for an initial hike to 4.00%. Once Warsh joins in as chair, the transitory argument will become the dominant narrative, with FOMC members complying at the fear of triggering a substantial equity market downturn by aggressively hiking. Rates will therefore stay at the 4.00% until about the third quarter of 2027."

"In the positive scenario, we see our current Fed base case of three more cuts at a quarterly pace starting in June still in play."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)