RBC GAM Senior Economist breaks down likely outcomes, including whether Iran war will be seen as growth or inflation shock
The outbreak of the American-Israeli war against Iran has caused many analysts to revise their view of Federal Reserve policy. Where consensus had initially priced in two 25 basis point rate cuts this year, both coming after the end of Fed Chair Jerome Powell’s term in May, the outbreak of war, Iran’s closure of the Strait of Hormuz, and the resulting spike in energy prices now have markets pricing in a single rate cut, coming at the very end of 2026. While the odds are that tomorrow’s FOMC meeting will see another interest rate hold, there are still unknowns about how the Fed digests this war and its impacts to US growth and inflation.
Josh Nye, Senior Economist at RBC Global Asset Management, joins consensus in predicting an interest rate hold at tomorrow’s meeting. He continues to hold the view, however, that we will see two interest rate cuts in the back half of 2026. As the Fed and Canadian advisors digest the economic and market impacts of war in the Arabian Gulf and its impact on oil prices, Nye offered some insight as to what they can watch for on Wednesday, and what that might tell us about how the Fed views the war.
“We are looking at a pretty significant energy price shock that is at least temporarily going to put quite a bit of upward pressure on inflation. In the US typically, central banks would look through a one-time price increase like that, particularly if it only lasts for a few months and you get back down mostly toward your previous projection for inflation,” Nye says. “A central bank typically looks through that kind of thing. It's a bit less straightforward this time around, just given our experience over the past several years with significantly higher inflation.”
Inflation remains a tetchy issue for the US Fed, given the fact that inflation expectations are not fully anchored back to the central bank’s two per cent target. US inflation has slowed, but remains well above target, giving the Fed less leeway to take even a transitory price shock. Nye expects on Wednesday that the Fed may have to engage in some hawkish language to keep inflation expectations under control. While Nye and RBC GAM still predict 2 cuts this year, he accepts some of the market consensus in shifting those cuts even later in 2026.
While Nye’s primary focus is on how the Fed reacts to energy prices as an inflationary shock, there has also been some noise about this energy price spike as a growth shock. Nye notes that normally a significant price increase in energy is viewed as a contributor to stagflation, but that the US’ move from energy importer to energy exporter offsets that stagflation risk somewhat. While high energy prices aren’t good news for US consumers, US energy companies can certainly benefit from this price move. Higher sustained prices may also motivate more capex and drilling activity in the US and other geographies further from the conflict zone, which could be stimulatory. From a growth standpoint, therefore, Nye sees this war as likely ‘neutral’ which would put the Fed’s focus back onto inflation.
Fed transition and policy shifts
Nye’s timeline for cuts this year has them coming after Fed Chair Jerome Powell leaves his role in May of this year. While the swirling issues of political influence and a looming Department of Justice probe into the Fed have not been fully dispelled, the nomination of Kevin Warsh as Powell’s successor has reassured markets somewhat about Fed independence. Nye notes that Warsh will have a challenging job of bringing unity on the Federal Open Markets Committee (FOMC) which has gone against its longstanding trend of consensus at recent past meetings. Nye believes that a mixture of inflation cooling faster than expected, and some softness in the labour market, should support some cuts under Warsh, provided those trends continue.
In the meantime, Nye will be watching for comments directly about energy price shocks at tomorrow’s announcement and press conference. He’ll also be watching for any comments on the labour market and how the Fed views those risks in light of inflation. Tomorrow’s meeting will also come with an update to the Summary of Economic Projections (SEP), which Nye says should tell us about how Fed views on appropriate monetary policy have shifted, with the likelihood that energy price shocks are baked into those views. For advisors making sense of the meeting to their clients, Nye believes that the ongoing likelihood of future easing remains the core question to answer.
“Our view heading into 2026 is that further easing in monetary policy is an important part of the growth outlook in 2026. That tends to be a good news story. The Fed cutting interest rates outside of a recession is a relatively rare occurrence,” Nye says. “I think we did a look back and you only see that about 15% of the time. And it tends to be a good backdrop for equity market returns and bond returns. And so we at the start of the year thought we were in that fairly good combination of rate cuts and being outside of a recession. And of course, this oil price shock is a risk to that thesis, but I think the market is suggesting that if oil prices do start to come back down in the coming months, then those rate cuts are not off the table.”
