Fed Stays Put as Iran Conflict Complicates Rate Policy

Amid a volatile geopolitical backdrop, the Federal Reserve (Fed) left its short-term lending rate unchanged on March 18. The U.S. short-term interest rate target remains in a range of 3.5% to 3.75%, where it’s been since December 2025.

The late-February launch of military strikes in Iran has complicated the Fed’s multiyear effort to ease inflation and restore interest rate neutrality. Surging oil prices and the uncertain economic fallout from the Middle East conflict prompted Fed officials to remain on the sidelines. However, they also left the door open to cutting interest rates at some point in 2026.

What the Fed Forecasts for 2026 Growth and Inflation

In addition to its interest rate announcement, the Fed released its first set of quarterly economic projections for the year:

• Gross Domestic Product (GDP): Fed officials slightly increased their GDP forecast for 2026. At the end of 2025, the median projected growth rate for 2026 was 2.3%. Now, the median forecast is for the economy to expand by 2.4%.

• Inflation: The Fed has lifted its forecast for core inflation from 2.5% to 2.7%. Policymakers expect inflation to ease to 2.2% by the end of 2027.

• Unemployment: The Fed’s forecasted unemployment rate remained unchanged at 4.4%.

Additionally, the Fed’s dot plot, a chart showing officials’ expectations for interest rates over time, continued to reflect further easing this year. Twelve of 19 Fed officials penciled in at least one rate cut in 2026, unchanged from December’s dot plot. However, several participants projected fewer reductions than they did in December.

Why U.S. Growth Could Rebound in Early 2026

Like the Fed, we expect the pace of growth to pick up this year. Last year’s longest-ever federal government shutdown weighed on economic growth, which expanded at an annualized pace of only 0.7% in the fourth quarter. This represented a sharp slowdown from the third-quarter growth rate of 4.4%.

Economic data released in early 2026 suggest growth may accelerate in the first quarter. As of March 18, the Federal Reserve Bank of Atlanta estimated the first-quarter annualized growth rate would climb to 2.7%.

We believe the economy should benefit from several tailwinds, including:

• A capital spending wave benefiting the artificial intelligence (AI) industry and other sectors.

• A more pro-growth federal regulatory backdrop.

• Better-than-expected federal tax refunds, providing a boost to consumer spending.

• A stabilizing labor market.

• The cumulative effects of last year’s Fed rate cuts, which could ease financial conditions.

… But Stagflation Risk May Return

However, these tailwinds may only prevail if the Iran conflict and oil supply shock don’t become prolonged. If they do, the economy may experience higher inflation and weaker growth, also known as stagflation.

Furthermore, while these factors should aid economic growth, some could also create headwinds for consumer prices. In fact, we believe inflation may creep higher through the first half of the year before potentially stabilizing mid-year.

Rising Oil Prices Add to Inflationary Uncertainty

Even before the military strikes in Iran, which sent oil prices soaring, inflation remained stalled at above-target levels. The core personal consumption expenditures index, the Fed’s preferred inflation gauge, rose to a 3.1% annualized pace in January, up from 3% in December.

Annual headline inflation, as measured by the Consumer Price Index (CPI), rose at a more modest pace of 2.4% in February, unchanged from January but down from 2.7% at year-end. The annual core CPI rate was 2.5% in February, unchanged from January and down from 2.6% in December.

Historically, central banks have generally overlooked oil price shocks, expecting the effects on inflation and growth to offset each other. This reaction assumes that higher oil prices will be temporary and that the Fed will restore its 2% inflation target. Achieving that inflation goal has proven challenging.

While inflation has moderated from its multidecade highs of June 2022, it’s remained above target for five years. Even if the Middle East conflict concludes quickly and oil prices retreat, we expect inflationary pressures to persist. Tariff policy is still developing, but our inflation views largely stem from our belief that economic growth should improve as the year unfolds.

Despite the Fed’s Forecast, a Rate Cut Isn’t Certain

The latest futures market data suggest the next Fed rate cut may arrive in December. However, with economic growth likely to remain healthy and inflationary pressures unlikely to ease much, we’re not convinced the Fed will ease at all.

But, given the level of uncertainty in today’s market, our outlook could change.

While inflation and employment data are key components of the Fed’s path forward, they aren’t the only factors. In particular, Fed chair nominee Kevin Warsh, a former Fed governor, may alter the central bank’s culture and course.

Regarding the Fed’s dual mandate of promoting price stability and full employment, Warsh believes price stability should dominate. In his view, full employment depends on sustained price stability, and without it, the Fed fails in its other responsibilities. He also believes productivity gains from AI should bolster growth without triggering high inflation.

Diversification Remains Crucial Amid Economic Uncertainty

As always, we believe maintaining a broadly diversified investment portfolio is a sensible strategy regardless of the economic or geopolitical backdrop. Our experience suggests that investors who maintain their long-term strategies while remaining mindful of emerging opportunities may improve their risk/reward potential.