How Geopolitical Risk Affects Federal Reserve Monetary Policy

At 2 a.m. Beijing time on March 19, the Federal Reserve announced no change to the benchmark interest rate, remaining at 3.50%-3.75%, in line with market expectations.

First, in terms of economic growth, signs of US economic weakness are gradually emerging. In Q4 2025, the US real GDP quarter-over-quarter annualized rate was revised to 0.7%, significantly slower than 4.4% in Q3. Employment data also underperformed market expectations, indicating a marginal slowdown in the labor market. The non-farm payroll report shows that in February 2026, US non-farm employment decreased by about 92,000 jobs, with the unemployment rate rising to 4.4%, reflecting broad industry employment declines. Inflation remains stable, with the US CPI year-over-year growth at 2.4% in February 2026, and core CPI at 2.5%. Although still above the Fed’s 2% target, the overall trend remains steady. Currently, heightened global geopolitical risks continue to introduce greater economic uncertainty for the Fed. Maintaining the interest rate at this meeting helps reinforce the downward trend in inflation and also preserves the Fed’s flexibility to observe economic developments and adjust future policies accordingly, balancing inflation control with economic stability.

Second, geopolitical risks influence the Fed’s monetary policy path. Recently, tensions in the Middle East have escalated again, with increased risks related to Iran. Geopolitical factors are becoming key variables affecting the global macro environment. Unlike traditional economic shocks, geopolitical risks have nonlinear and uncertain impacts on the economy, affecting energy prices, financial market risk appetite, corporate investment decisions, and inflation expectations. According to research from NBER working papers, energy markets respond significantly, reflecting high sensitivity of energy supply to geopolitical risks. Rising energy prices can further transmit through cost channels to agricultural prices, amplifying spillover effects on global commodity markets. Another study, based on scenario survey experiments, examined how geopolitical conflicts influence residents’ economic expectations and consumption behavior. Results show that such conflicts not only impact supply but also suppress consumption through expectation channels, intensifying macroeconomic volatility.

Finally, there are three main channels through which geopolitical risks transmit to the US economy. First, price transmission. Although the US has relatively low direct dependence on Middle Eastern energy, domestic energy prices tend to rise with international oil prices. Higher energy prices also push up US import prices through global supply chains. Second, fiscal pressure. Geopolitical conflicts often lead to increased military spending. Under current high-interest-rate conditions, US fiscal debt pressures have already risen significantly. If energy shocks boost inflation expectations, the Fed may keep interest rates high longer, further increasing interest expense and worsening US debt issues. Third, stagflation risk. Amid the overall slowdown of the US economy, geopolitical shocks could simultaneously dampen growth, raising the risk of stagflation. Therefore, it is expected that the Fed will remain cautious and hawkish in its policy stance to prevent inflation expectations from spiraling out of control.