Federal Reserve officials warn that "interest rate cuts should be paused": The Iran war makes inflation more dangerous than unemployment.

The Iran war is sending oil prices soaring, and three Federal Reserve board members sounded the alarm in unison on Thursday: inflation risks have now surpassed employment risks. At this stage, they are inclined to keep interest rates unchanged and stand back to observe the war’s real economic impact.
(Backgrounder: Bloomberg warns: the Iran war’s impact is intensifying, and traders are betting on an emergency rate hike by the Federal Reserve within weeks)
(Additional context: fighting in the Middle East devastates the global economy! OECD: U.S. inflation could surge to 4.2%, and the Federal Reserve will delay rate cuts while Europe may be forced to raise rates)

As the Iran conflict continues to rage, the surge in oil prices is reshaping the Federal Reserve’s risk assessment. On Thursday, after delivering a speech in New Haven, Connecticut, Federal Reserve governor Lisa Cook said clearly: “Because of the Iran war, inflation risks are now greater. As for the labor market, I think it is in a balanced state, but that balance is fragile.”

This marks the first time a Federal Reserve official has so plainly identified that the Middle East conflict has shifted the balance of risks—concerns over inflation have outweighed worries about the jobs market. Cook also warned that the conflict’s impact may be transmitted through oil prices and create a “substantial effect” on the formation of broader prices.

Barr and Miran voice support in agreement: observe first, then act

Cook’s two colleagues also spoke on the same day, taking a similarly cautious stance. Federal Reserve governor Michael Barr, speaking at an event at the Brookings Institution, said: “It is reasonable to take some time to assess the situation. Our current policy stance puts us in a position of strength, allowing us to maintain stability while evaluating new data.” The implication is that in the near term, the Federal Reserve should hold steady.

Federal Reserve governor Stephen Miran, meanwhile, said at an event in Miami that he still expects that in the next 12 months, the potential inflation rate will move toward the 2% target, but he also acknowledged that the war introduces uncertainty and requires continued monitoring.

Miran on balance-sheet reduction: it can shrink by 1–2 trillion, but the pace must be slow

In his speech, Miran also floated another key discussion point—the scope for shrinking the Federal Reserve’s balance sheet. He believes the Federal Reserve could potentially reduce the balance-sheet size by 1 to 2 trillion U.S. dollars, without triggering turmoil in financial markets, but only on the condition that accompanying measures are in place, and that the process is pushed forward slowly on a year-by-year basis.

“Once this process is initiated, I would recommend that we reduce slowly, to ensure the private sector can absorb all the securities that are stripped away from our balance sheet.” Miran said, “I’m excited about all of this being able to happen, but if it does happen—or once it happens—I expect the progress to be slow.”

The remarks from the three officials clearly convey the Federal Reserve’s collective position right now: inflation pressure stemming from the Iran war cannot be ignored, and holding off on action is the safest choice until the situation becomes clear.