The Federal Reserve left interest rates unchanged Wednesday in the most divisive vote in decades. Three opponents argue that the Iranian oil shock changed the calculus.
Major central banks kept interest rates on hold last week, but the relative calm came with some caveats. Policymakers said they were prepared to raise interest rates if soaring energy prices caused by the U.S.-Israel conflict with Iran cause inflation to rise further.
The Fed voted to leave the deal unchanged, but the tone of the decision was not unanimous. Three Fed officials called out the statement’s “accommodation bias” and argued that the language no longer reflects economic reality. Their dissent suggests that the window for rate cuts may be closing sooner than the market expected.
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The European Central Bank (ECB) and the Bank of Japan (BOJ) each maintained interest rates but took a more conditional stance. ECB President Christine Lagarde said the ECB was “certainly moving away” from its base scenario and acknowledged that raising interest rates was one of the options being discussed, but the ECB stopped short of signaling that a hike was imminent.
At the Bank of Japan, holding was even more difficult. Three out of nine board members opposed an immediate interest rate hike, and Governor Kazuo Ueda warned that the central bank would raise interest rates if the Iranian oil crisis causes a second inflationary effect.
Signals from overseas are important for buyers and sellers monitoring mortgage rates. The global shift to tightening policies is likely to put upward pressure on long-term borrowing costs in the United States.
The most divided Fed in decades
The Fed left interest rates unchanged last Wednesday by an 8-4 vote (the most no votes since 1992), but the four “no” votes pointed in two very different directions.
Three regional bank presidents, Beth Hammack of Cleveland, Neal Kashkari of Minneapolis, and Rory Logan of Dallas, agreed to leave the rate unchanged, but opposed the statement’s “accommodative bias” that suggested rate cuts were more likely than hikes. Fed Governor Stephen Milan completely reversed course and opposed it in favor of an immediate one-quarter rate cut.
By Friday, all three opponents of moderation bias had issued the same warning. The Iran war has changed the calculus, and the expression of accommodation bias is no longer defensible. Kashkari warned that an extended Hormuz shutdown could cause a price shock that the Fed cannot absorb without “potentially a series” of rate hikes.
“The price shock could be much larger than currently expected as the closure of the Strait of Hormuz could be extended and further damage to the Middle East’s energy and commodity infrastructure,” Kashkari said in a statement.
In his post-meeting press conference, Chairman Powell acknowledged that there is growing support within the committee to move away from the easing bias and favor more neutral language, one that equates the likelihood of rate hikes and rate cuts.
Powell said he didn’t think there was a need to rush into making changes at this meeting given the uncertainty ahead, but stopped short of ruling out changes at the next meeting. With oil prices soaring from $70 a barrel at the start of the conflict two months ago to $126 a barrel this week, and headline PCE inflation at 3.5% as of March, the data is trending in the wrong direction.
In a move that drew as much attention as the vote itself, Powell confirmed that he would step down as chairman when his term expires on May 15, but would remain on the Fed’s board until January 2028. Trump’s successor, Kevin Warsh, was approved by the Senate Banking Committee on the same day.
The path forward is much more certain.
Following the Fed’s decision last week to keep the federal funds rate on hold, Bankrate financial analyst Stephen Cates, CFP, said the Fed’s path forward is far from certain, given high oil prices and smoldering underlying inflation in goods and services.
“Labor market concerns seem to have faded into the background,” Cates said. “The rapidly changing global economic landscape means the Fed is less able to provide forward guidance given the data-dependent nature of this headwind environment.”
Cates added that while the direct relationship between Federal Reserve policy and mortgage rates is loose, the policy outlook still has a significant impact on how markets interpret overall economic conditions.
“The Fed’s cautious outlook is contributing to more conservative lending standards through tighter risk controls, higher interest rates, and wider spreads between the highest and lowest offered rates,” Cates said. “Due to the interplay of lender incentives, market complexity, and consumer behavior, borrowers may not be able to find the best mortgage rate by taking the time and effort to rigorously compare lenders and improve their qualifications.”
The next Fed meeting will be held in June.
Inflation analyst Omer Sharif warned in a note to clients that the Fed could come into its June meeting with the consumer price index in May above 4%. This would be a level not seen since the post-coronavirus surge and the aftermath of Russia’s invasion of Ukraine in 2022.
That would put Kevin Warsh in a politically difficult position from day one. The Senate is expected to vote on his confirmation as early as the week of May 11, possibly days before Mr. Powell’s term ends on May 15, and Mr. Trump has publicly called for rate cuts. But if the inflation data goes in the direction Mr. Sharif fears, the mathematics could call for the opposite result.
For the housing market, the stakes are direct. Chairman Powell said at a press conference that there was growing support within the committee to eliminate the moderation bias, and that there was no need to rush to make changes at this meeting. The next meeting will be June 16-17, when Warsh will serve as chair for the first time.
If that change were to occur, already rising mortgage rates would be under renewed upward pressure just as the summer shopping season begins.
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