Jerome Powell says the Fed doesn't have to hike interest rates because of the Iran war — yet

Federal Reserve Chair Jerome Powell said Monday that the central bank sees no need to raise interest rates in response to the oil price shock from the Iran war — at least for now.

Powell presented the Fed's case for patience to the Harvard audience: the price effects of energy shocks usually dissipate on their own, while rate moves ripple through the economy far too slowly to offset them. "By the time the effects of a tightening in monetary policy takes effect, the oil price shock is probably long gone, and you're weighing on the economy at a time when it's not appropriate," he said, according to CNBC.

Powell said the energy shock has so far left longer-run price expectations intact, removing what would otherwise be the central bank's most pressing reason to raise rates. He left the door open to action, however. "We will eventually maybe face the question of what to do here. We're not really facing it yet because we don't know what the economic effects will be," he said.

The remarks moved markets. Market pricing had shifted sharply by the end of last week, with traders placing the odds of a December rate hike above 50% on the expectation that the Fed would have to respond to rising fuel costs, according to CNBC. By the time Powell left the stage, that probability had dropped to 2.2%.

The Fed left its benchmark rate unchanged at 3.5% to 3.75% at its March 18 meeting — the second straight hold — as policymakers navigated conflicting signals from rising energy costs and an uneven labor market. The U.S. economy has run above the Fed's 2% inflation target for five years.

Now in its fifth week, the Iran war has choked off traffic through the Strait of Hormuz and driven up global energy costs. Brent crude topped $116 a barrel Monday after Trump said he would destroy Iran's energy infrastructure unless a deal is reached to end the conflict and reopen the strait, according to CNN; the strait accounts for roughly 20% of global oil flows. Commodity spillovers have extended beyond oil, with plastic and fertilizer costs also climbing.

The conflict has placed the Fed in a difficult spot. Higher energy costs could push inflation further above target while simultaneously weighing on economic growth and employment. Powell noted that the Fed's dual mandate of stable prices and maximum employment could pull in opposite directions. The Wall Street Journal reported that in recent weeks Powell's colleagues have communicated a much more restrictive set of preconditions for easing — specifically, unmistakable signs of job market stress or a fresh downtrend in price growth.

A critical variable, Powell said, is whether Americans' expectations about future inflation remain stable. A prolonged conflict could erode that confidence. "You can have a series of these supply shocks and that can lead the public generally — businesses, price setters, households — to start expecting higher inflation over time," he said.

The Harvard appearance comes as Powell approaches the end of his tenure, with his chairmanship set to lapse in mid-May. No Senate confirmation hearing has been set for Kevin Warsh, the former Fed governor Trump nominated to lead the central bank. Sen. Thom Tillis of North Carolina, a Republican, has said he will hold up Warsh's confirmation pending the outcome of a Justice Department inquiry into Powell. Should no successor be in place when his term ends, Powell has said he would serve as "chair pro tempore." Asked to comment on Warsh's stated preference for lower rates, Powell declined: "I'm not going to swing at that pitch."