The recent escalation of conflict in Iran has triggered a notable increase in gas prices, a development with wide-reaching financial consequences for many Americans. Beyond the direct impact on fuel costs, the war has also contributed to a significant rise in longer-term interest rates, affecting mortgages, auto loans, and business borrowing expenses. This surge in borrowing costs is reshaping expectations around Federal Reserve monetary policy, signaling a shift away from anticipated rate cuts toward the possibility of interest rate hikes.
Since the onset of the conflict on February 28, longer-term interest rates have climbed rapidly. Before the war, rates were relatively stable, but the uncertainty and inflationary pressures introduced by the conflict have caused yields to rise. The yield on the 10-year U.S. Treasury note, a key benchmark for consumer and business loans, has increased from just under 4% to nearly 4.4%. This rise has pushed mortgage rates upward, with the average 30-year fixed mortgage rate climbing to 6.22%, up from just below 6% prior to the war, according to Freddie Mac. Such increases directly raise the cost of homeownership and borrowing for many Americans.
Wall Street investors have adjusted their expectations accordingly. Whereas early in the year, the dominant discussion revolved around how many times the Federal Reserve might cut interest rates, the conversation has shifted dramatically. Now, the probability of the Fed implementing a rate hike by October stands at nearly 25%, a significant jump from virtually zero just one week earlier. Futures pricing tracked by the CME FedWatch tool reveal that investors no longer expect any rate reductions this year. This reversal reflects growing concerns about inflation and the economic impact of higher energy prices.
Despite this shift, most economists remain cautious, viewing an actual rate hike as unlikely, though no longer impossible. Krishna Guha, head of economics at Evercore ISI, suggests that while interest rate cuts have not been abandoned, they are likely to be delayed — possibly until September, December, or even indefinitely into 2027. This cautious stance reflects the complex economic environment shaped by the war and its ripple effects on inflation and growth.
Federal Reserve officials themselves have expressed a nuanced view on the situation. Austan Goolsbee, president of the Federal Reserve Bank of Chicago, noted in an interview that if inflation rises while unemployment remains stable, and if Americans begin to expect higher inflation in the future, then “rate increases have to be on the table.” Goolsbee participates in the Federal Open Market Committee meetings but is not a voting member this year. Meanwhile, Mary Daly, president of the San Francisco Fed, emphasized the uncertainty created by the Iran conflict, stating there is “no single most-likely path” for the Fed’s key interest rate. This suggests that the Fed may raise, lower, or hold rates steady in the near term, depending on how economic conditions evolve.
The Federal Reserve faces a particularly challenging dilemma because of the dual effects of rising gas prices. On one hand, higher energy costs tend to fuel inflation, pushing up consumer prices and potentially prompting the Fed to raise rates to keep inflation in check. On the other hand, sustained elevated gas prices can constrain consumer spending on other goods and services, slowing economic growth and potentially increasing unemployment. This slowdown could argue for a more accommodative monetary policy with lower rates to support the economy.
Jonathan Pingle, an economist at UBS, encapsulated this dilemma by saying, “On net more inflation means probably higher rates. On the other hand, that energy price shock is going to be a headwind to growth.” Typically, central banks might look past temporary spikes in gas prices when setting interest rates, treating such inflation as transitory. However, Jerome Powell, Chair of the Federal Reserve, indicated at a recent news conference that dismissing the inflationary impact as temporary is more difficult now, given that inflation has remained above the Fed’s 2% target for five years. This prolonged period of elevated inflation has eroded public confidence in the economy and complicates the Fed’s policy decisions.
Currently, the Fed appears more focused on the risk of rising inflation than on unemployment concerns. Economists at UBS forecast that the Fed’s preferred inflation measure could jump to 3.4% this month and remain elevated, ending the year at around 3%, well above the central bank’s target. Meanwhile, the unemployment rate remains low and stable, which reduces immediate pressure to lower rates from a labor market perspective. Goolsbee highlighted this balance, noting that