Fed Continues to Hold Off on Rate Cuts — Middle East
The fact that the world's largest central bank is unable to act for two consecutive meetings indicates that the U.S. economy is caught between geopolitical risks and inflationary pressures, marking a structural turning point that will ripple through global markets, exchange rates, and emerging economies.
── Understand in 3 points ─────────
- • The Fed decided to keep the policy interest rate (federal funds rate) at 4.25-4.50% at the FOMC on March 18, 2026.
- • The decision to forgo a rate cut marks the second consecutive meeting (January and March 2026), indicating a prolonged interruption of the rate-cutting cycle that began in September 2024.
- • Chair Powell explicitly stated in a press conference that "the impact of the Middle East situation on the American economy is uncertain," positioning geopolitical risk as a key variable in monetary policy decisions.
── NOW PATTERN ─────────
The Fed's monetary policy is path-dependently constrained by exogenous shocks—Middle East geopolitical risk and accelerating inflation—trapping it in a "policy dilemma" where it can neither cut nor raise rates.
── Probabilities and Responses ──────
• Base case 55% — Maintenance of "patience" language in FOMC statement, CPI stable around 3%, crude oil in the $80-90 range, announcement of Powell's successor.
• Bull case 20% — Ceasefire agreement or diplomatic breakthrough in the Middle East, crude oil prices falling below $70, sharp decline in CPI to below 2.5%, change in Fed's forward guidance.
• Bear case 25% — Signs of an Israeli attack on Iranian nuclear facilities, navigation disruption incidents in the Strait of Hormuz, crude oil breaking $100, CPI exceeding 4%, sharp widening of credit spreads.
📡 THE SIGNAL — What Happened
Why it matters: The fact that the world's largest central bank is unable to act for two consecutive meetings indicates that the U.S. economy is caught between geopolitical risks and inflationary pressures, marking a structural turning point that will ripple through global markets, exchange rates, and emerging economies.
- Monetary Policy — The Fed decided to keep the policy interest rate (federal funds rate) at 4.25-4.50% at the FOMC on March 18, 2026.
- Monetary Policy — The decision to forgo a rate cut marks the second consecutive meeting (January and March 2026), indicating a prolonged interruption of the rate-cutting cycle that began in September 2024.
- Geopolitics — Chair Powell explicitly stated in a press conference that "the impact of the Middle East situation on the American economy is uncertain," positioning geopolitical risk as a key variable in monetary policy decisions.
- Inflation — The U.S. Consumer Price Index (CPI) for February 2026 rose 3.1% year-on-year, remaining significantly above the Fed's 2% target.
- Inflation — The rise in energy prices is re-accelerating, with crude oil prices (WTI) around $85 per barrel as of March 2026, up from the $70 range at the end of 2025.
- Employment — Non-farm payrolls in February 2026 maintained a solid increase of 175,000 month-on-month, and the unemployment rate remained stable at 3.9%.
- Markets — Following the FOMC statement, the U.S. 10-year Treasury yield hovered around 4.35%, reflecting continued market pricing of diminished rate cut expectations.
- Exchange Rates — The USD/JPY exchange rate is trading in the 152 yen range, with yen depreciation pressure persisting due to receding expectations of a narrowing U.S.-Japan interest rate differential.
- Geopolitics — Tensions between Israel and Iran have escalated again in the Middle East in 2026, with navigation risks in the Strait of Hormuz amplifying uncertainty in energy markets.
- Economic Outlook — The Fed revised down its GDP growth forecast for 2026 from 2.0% to 1.7%, signaling caution towards a stagflationary scenario.
- Monetary Policy — In the FOMC participants' dot plot (interest rate projections), the median number of rate cuts for 2026 decreased from the previous 3 times to 1 time.
- Politics — Ahead of the U.S. midterm elections in November 2026, the Trump administration is intensifying pressure on the Fed for rate cuts, making central bank independence a political focal point.
To understand why the Fed decided to forgo rate cuts for two consecutive meetings, it is necessary to survey the trajectory of U.S. monetary policy in the 2020s.
In 2020, to respond to the COVID-19 pandemic, the Fed lowered the federal funds rate to near zero and implemented large-scale quantitative easing. In addition, trillions of dollars in fiscal stimulus by the Biden administration led to a rapid acceleration of inflation from late 2021. The Fed initially maintained its "transitory" assessment but finally pivoted to rate hikes in March 2022, raising rates at a historic pace for approximately a year and a half thereafter. The federal funds rate reached a 22-year high of 5.25-5.50% in July 2023.
This rapid monetary tightening showed some effectiveness in curbing inflation, with CPI falling from its peak of 9.1% in June 2022 to the low 3% range by mid-2024. In response, the Fed initiated its first rate cut in four and a half years in September 2024, and markets became optimistic about a "soft landing." Rate cuts of 0.25% each were implemented for three consecutive meetings in September, November, and December 2024, bringing the federal funds rate down to 4.25-4.50%.
However, the situation changed dramatically in 2025. First, President Trump (second term), who took office in January 2025, imposed large-scale tariffs on China, the EU, Mexico, and others, pushing up import prices. Furthermore, the situation in the Middle East deteriorated. In the latter half of 2025, the risk of direct military conflict between Israel and Iran increased, threatening navigation safety in the Strait of Hormuz. Crude oil prices resumed an upward trend, and rising energy costs pushed up CPI.
The Fed temporarily paused rate cuts at the January 2025 FOMC, and although it implemented a 0.25% cut in March, it subsequently reverted to a wait-and-see stance. In the latter half of 2025, the stickiness of inflation was re-recognized, and the pace of rate cuts slowed significantly. For the full year 2025, total rate cuts amounted to only 0.50%, a significant divergence from the 1.00-1.50% cuts the market had expected at the beginning of the year.
Entering 2026, the Middle East situation became even more unstable. The possibility of an Israeli attack on Iranian nuclear facilities was discussed, and the risk premium in the crude oil market expanded. Simultaneously, the cumulative effects of the Trump administration's tariff policies began to be passed on to prices through supply chains, and CPI appeared to become fixed in the 3% range once again.
Against this structural backdrop, the Fed is caught in a classic "double bind." Cutting rates would heighten the risk of inflation resurgence, while continuing to hold them steady would lead to slower economic growth and financial market instability. Chair Powell's explicit mention of the Middle East situation is unusual and highlights the reality that the Fed must incorporate geopolitical variables, not just pure economic data, into the core of its policy decisions.
This situation bears a striking structural resemblance to the dilemma faced by the Fed during the 1970s oil shocks. At that time, Fed Chair Arthur Burns was also forced to make policy decisions caught between Middle East geopolitical risks (Fourth Arab-Israeli War, oil embargo) and inflationary pressures, ultimately prolonging inflation. In 2026, the Fed, while aware of these historical lessons, is struggling to find an optimal solution amidst the complexities of the modern global economy. The scenario where a central bank's monetary policy is effectively "held hostage" by geopolitical risks is evidence that the breakdown of the stable post-Cold War international order is now impacting even macroeconomic policy.
The delta: With the Fed forgoing rate cuts for two consecutive meetings and Chair Powell explicitly citing the Middle East situation as a risk factor, the pattern of monetary policy being "path-dependently" constrained by geopolitical risks has become clear. The rate-cutting cycle that began in autumn 2024 has effectively been interrupted, and market interest rate expectations have significantly receded.
🔍 BETWEEN THE LINES — What the News Isn't Saying
Chair Powell's explicit mention of "the Middle East situation" actually reflects the Fed's inability to directly criticize inflationary pressures caused by Trump's tariffs. While Middle East risks certainly exist, what the Fed is truly wary of is the cumulative inflationary effect of tariff policies, and it is using geopolitics as a "smokescreen" to avoid a direct confrontation with the administration. Furthermore, the sharp reduction in the dot plot's projected rate cuts from three to one indicates a rapid increase in hawkish sentiment within the FOMC, implying that Chair Powell's dovish "patience" approach is becoming internally difficult to sustain.
NOW PATTERN
Path Dependency × Coordination Failure × Escalation Spiral
The Fed's monetary policy is path-dependently constrained by exogenous shocks—Middle East geopolitical risk and accelerating inflation—trapping it in a "policy dilemma" where it can neither cut nor raise rates.
Intersection of Dynamics
The three structural patterns—path dependency, coordination failure, and escalation spiral—are interconnected and mutually reinforcing, creating the Fed's policy gridlock. Understanding this interaction is key to grasping the essence of the current situation.
First, path dependency and coordination failure are forming an "institutional lock-in." The simultaneous effects of the Fed's policy space being narrowed by past rate hike cycles (path dependency) and the breakdown of coordination with fiscal policy (coordination failure) are creating an "institutional cul-de-sac" where problems that cannot be solved by monetary policy alone must be addressed solely through monetary policy. Ideally, the Fed's policy leeway would expand by linking with fiscal and diplomatic responses such as tariff policy reviews and stabilization of Middle East diplomacy, but this coordination mechanism is not functioning.
Next, there is a mechanism by which the escalation spiral reinforces path dependency. The deterioration of the Middle East situation pushes up energy prices and maintains inflationary pressures, further distancing the "exit" for the Fed to pivot to rate cuts. Without the escalation spiral, inflation might have naturally declined, making an escape from path dependency possible. However, the repeated occurrence of exogenous geopolitical shocks repeatedly postpones the timing of policy shifts, solidifying path dependency.
Furthermore, the interaction between coordination failure and the escalation spiral is causing "policy fragmentation." A vicious cycle is emerging where the lack of international policy coordination prevents the control of Middle East conflicts, and uncontrolled conflicts further hinder international cooperation. The Fed is inherently an institution that does not engage in such diplomatic and security issues, but it is placed in a position where it must bear the economic consequences entirely.
As a result of this triple interaction, the Fed is forced into a passive equilibrium of "having no choice but to wait." However, waiting itself accumulates risks. Prolonged interest rate stagnation will lead to an economic slowdown, and when the Fed is eventually forced to cut rates, it will do so amidst still-high inflation, risking a 1970s-style stagflationary situation. The Fed's choice at the intersection of these three dynamics is a turning point that will determine the future direction of the global economy.
📚 PATTERN HISTORY
1973-1974: First Oil Shock and the Fed's Policy Missteps
Geopolitical crises in the Middle East (Fourth Arab-Israeli War, oil embargo) caused energy prices to skyrocket, and the Fed (Chair Arthur Burns) wavered between curbing inflation and sustaining economic growth, ultimately prolonging stagflation with half-hearted tightening.
Structural similarities with the present: When geopolitical risk becomes an exogenous factor for inflation, monetary policy alone has structural limitations. Half-hearted responses lead to the worst outcomes.
1979-1980: Second Oil Shock and the Volcker Shock
In response to the energy crisis caused by the Iranian Revolution and double-digit inflation, Fed Chair Volcker implemented an ultra-hawkish policy, raising the federal funds rate to 20%, which suppressed inflation but led to a severe recession.
Structural similarities with the present: "Excessive tightening" in response to geopolitically-driven inflation also incurs significant costs. Finding the right balance is extremely difficult.
1998: Asian Financial Crisis, Russian Crisis, and the Fed's Emergency Rate Cuts
Crises in emerging markets spilled over into U.S. financial markets (LTCM collapse), and the Fed responded with three emergency rate cuts. This was an instance where external shocks altered U.S. monetary policy.
Structural similarities with the present: Global risk events can abruptly change the Fed's policy direction. Even while claiming to be "data-dependent," responses to tail risks can sometimes dominate policy.
2019: U.S.-China Trade War and the Fed's "Insurance Rate Cuts"
The Trump administration's (first term) tariffs on China worsened the economic outlook, leading the Fed to implement three "insurance rate cuts" to prevent a recession. Trade policy effectively dictated monetary policy.
Structural similarities with the present: The dynamic of an administration's trade policy tying the Fed's hands has precedents. This time, Middle East risk is added to tariffs, making the constraint even stronger.
2022-2023: Ukraine War and the ECB's Accelerated Rate Hikes
The energy crisis caused by Russia's invasion of Ukraine rapidly accelerated inflation in the Eurozone, forcing the ECB to raise rates at an unprecedented pace. This is a recent example where geopolitical risk fundamentally altered a central bank's policy path.
Structural similarities with the present: Surging energy prices due to geopolitical shocks fundamentally overturn central banks' policy plans. The ECB's experience is a recent leading indicator of the Fed's current predicament.
Patterns Revealed by History
Historically, the pattern of geopolitical risks centered in the Middle East and energy price shocks constraining central bank monetary policy has recurred since the 1970s. The common structure is as follows: First, exogenous geopolitical shocks directly lead to inflation through energy prices. Second, central banks face a dilemma between their primary mandate (price stability) and maintaining economic growth. Third, fundamental solutions are impossible through monetary policy alone.
The "half-hearted response" of the Burns Fed in 1973 led to stagflation, and the "excessive tightening" of the Volcker Fed in 1979 led to a severe recession. Both extremes incurred significant costs. The Powell Fed in 2026, while mindful of both these lessons, is taking a third option: "waiting." However, history shows that "waiting" also comes with costs. Just as the Fed's inaction in the 1970s led to the entrenchment of inflation expectations, making the problem harder to solve, the 2026 Fed also risks an upward shift in inflation expectations due to prolonged stagnation. The pattern of history reveals the harsh reality that there is no "right answer" for central banks facing geopolitically-driven inflation, only "lesser mistakes."
🔮 NEXT SCENARIOS
The Fed will keep the policy interest rate at 4.25-4.50% throughout the first half of 2026, forgoing rate cuts at the next FOMC meetings (May and June). Tensions in the Middle East will persist but without escalating to full-scale war, and crude oil prices will trade in the $80-90 range. CPI will remain elevated around 3%, and convergence to the Fed's 2% target will remain out of sight. Chair Powell's term expires in May 2026, and President Trump will nominate a dovish successor. Under the new chair, a 0.25% rate cut will be implemented at the July or September FOMC, but this will be perceived by the market as a result of political pressure rather than improved economic data, slightly eroding the Fed's credibility. Total rate cuts for 2026 will be limited to 0.25-0.50%, with the federal funds rate ending the year in the 3.75-4.25% range. USD/JPY will trade in the 150-155 yen range, and the U.S. stock market will remain flat. GDP growth will be 1.5-2.0%, below potential growth, but without falling into recession. Emerging economies will struggle with persistently high interest rates but will not develop into full-blown debt crises.
Investment/Action Implications: Maintenance of "patience" language in FOMC statement, CPI stable around 3%, crude oil in the $80-90 range, announcement of Powell's successor.
The Middle East situation unexpectedly improves. Some informal agreement for de-escalation is reached between Israel and Iran, and the risk premium in the Strait of Hormuz declines. Crude oil prices fall to the $70 range, easing energy-driven inflationary pressures. In response to this environmental change, CPI declines to the 2.5% range by mid-2026, and the Fed resumes rate cuts at the June FOMC. Markets evaluate this as a "Goldilocks economy," leading to rising stock markets and falling long-term interest rates. The Fed implements a total of 0.75% in rate cuts in the latter half of 2026, with the federal funds rate falling to 3.50-3.75% by year-end. The dollar weakens and the yen strengthens, with USD/JPY heading towards the 140 yen range. The Bank of Japan accelerates monetary normalization, and a global trend of "interest rate normalization" strengthens. Capital flows to emerging economies improve, and the global economy returns to a stable growth trajectory. This scenario is only realized if the greatest uncertainty, geopolitical risk, is resolved; its probability is low, but its impact is significant. U.S. GDP growth maintains above 2.0%, and the employment market remains robust.
Investment/Action Implications: Ceasefire agreement or diplomatic breakthrough in the Middle East, crude oil prices falling below $70, sharp decline in CPI to below 2.5%, change in Fed's forward guidance.
The Middle East situation deteriorates decisively. Israel carries out a military attack on Iranian nuclear facilities, and Iran retaliates with a partial blockade of the Strait of Hormuz. Crude oil prices temporarily surge to $120-150, delivering a severe stagflationary shock to the global economy. CPI exceeds 4%, forcing the Fed to consider resuming rate hikes to curb inflation. However, simultaneously, the economy rapidly decelerates, and GDP falls into negative growth. A 1970s-style stagflation materializes, and the Fed faces the impossible challenge of "simultaneously addressing inflation and recession." Financial markets plunge into chaos, with the S&P 500 falling by over 20% and the U.S. 10-year Treasury yield surging above 5%. USD/JPY breaks 160 yen, and Japan is hit by a double shock of import inflation and rising interest rates. Currency crises cascade through emerging economies, and defaults on dollar-denominated debt become widespread. The Trump administration responds with emergency oil reserve releases and strengthened sanctions against Iran, but without achieving a fundamental solution. The Fed's credibility is severely shaken, potentially escalating into an institutional crisis concerning central bank independence. The U.S. economy enters a recession in the latter half of 2026, significantly impacting the midterm elections.
Investment/Action Implications: Signs of an Israeli attack on Iranian nuclear facilities, navigation disruption incidents in the Strait of Hormuz, crude oil breaking $100, CPI exceeding 4%, sharp widening of credit spreads.
Key Triggers to Watch
- Interest rate decision and dot plot update at the next FOMC (May 6-7, 2026): May 7, 2026
- Expiration of Fed Chair Powell's term and announcement of successor: By end of May 2026
- Military escalation between Israel and Iran (presence/absence of nuclear facility attack): April-June 2026
- U.S. March CPI announcement in April 2026 (confirmation of inflation re-acceleration): Around April 10, 2026
- Intensity of Trump administration's pressure on the Fed ahead of the November 2026 U.S. midterm elections: June-November 2026
🔄 TRACKING LOOP
Next Trigger: FOMC May 6-7, 2026 — Likely Powell's final meeting, with the focus on continued hold or a "farewell cut." The economic projections and dot plot released concurrently will determine the future policy path.
Continuation of this pattern: Tracking Theme: Resumption timing of the Fed's rate-cutting cycle — The next milestones are the May 2026 FOMC (the last meeting before Powell's term expires), followed by the appointment of the new chair and the June FOMC. Continue monitoring the trifecta of Middle East situation, crude oil prices, and CPI.
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