Fed’s Inflation Scars Give Rate Cuts a Higher Bar

Key Takeaways

• The Federal Reserve is cautious about cutting interest rates due to persistent inflation risks from energy price shocks.
• Oil prices have dropped but remain significantly higher than at the start of the year, adding inflationary pressure.
• Fed officials are concerned about missing their 2% inflation target for five years, which could impact public confidence.

The Federal Reserve is fighting one inflation battle after another, as one Fed official put it on Friday.

It’s a risk that could make the central bank hesitant to cut interest rates again soon, even as Friday’s reopening of the Strait of Hormuz prompted optimism in markets. Despite Friday’s drop, oil prices remain far above their levels before the Iran war.

If sustained, higher energy prices would be the latest shock to inflation. Prices spiked in 2021 and 2022, and though inflation has mostly cooled since, the seemingly one-time hit from tariffs last year hasn’t had enough time to fade.

What’s more, Fed officials are keen on bringing up one uncomfortable fact: they haven’t met their 2% inflation target in five years. That raises the risk that the public will start to believe the Fed isn’t committed to its inflation target, Chicago Fed President Austan Goolsbee said on Tuesday.

“This is why I’m afraid,” Goolsbee said at the Semafor World Economy conference.1 “If you add a big inflationary shock from energy before the other one went away, are we getting into an environment where [the Fed’s] credibility takes a hit?”

Why This Matters

Persistent inflation and energy shocks could delay rate cuts, affecting borrowing costs and investment decisions for consumers and investors.

Prices on the Brent crude oil benchmark fell to around $90 a barrel on Friday, a welcome reprieve after the over $110 mark they reached at several points of the war. But they’ve still shot up from about $60 a barrel at the start of the year.

There’s a reasonable likelihood that the market “will return to something close to normal” if the Strait of Hormuz stays open, Fed Governor Chris Waller said on Friday.2 A more temporary disruption could let the Fed look past the oil shock more easily, helping the Fed resume the rate cuts that officials foresaw for this year before the war began.

But Waller, who’d been a key rate-cut supporter before the war, said he’s more “cautious about rate cuts now” and would prefer to hold off until later in the year. And he cited the still-significant risks that continued disruption in energy markets “will bleed into other prices.”

The Fed is getting “one transitory shock after another,” Waller said, alluding to the Fed’s faulty forecasts in 2021 that pandemic-era price shocks would be “transitory.” Prices proved far more pernicious, with inflation rising at an annual pace of 9% at their peak in 2022.

“Learning from that experience, I will be cautious when faced with a sequence of transitory shocks,” Waller said. “While intellectually it makes sense to look through each shock, with a sequence of shocks, policymakers need to be more vigilant.”

Well-Positioned For Now

The remarks were among the last as Fed officials entered a communications blackout ahead of their April 28-29 meeting.

Markets see virtually no chance of the Fed changing rates at that meeting. But Friday’s news made traders more optimistic that rate cuts could come this year, continuing the Fed’s cuts from 2024 and 2025.

The odds of a cut this year shot up to over 50%, up from less than 30% a day earlier, according to the CME Group’s FedWatch tool, which uses futures market pricing to determine Fed meeting probabilities. But traders also started betting on a rate hike by year-end again, with the FedWatch tool showing an 8% probability.

Rate cut hopes may be misplaced, since the energy shock “may have a longer tail than investors currently believe,” wrote Scott Anderson, BMO’s chief U.S. economist. After all, he noted, energy officials say it’s the largest disruption to oil supply in history.3

“I would like to put on rose-colored glasses and believe all is well, but the situation could still go off the rails,” Anderson said.

With the outlook far from clear, analysts expect the main message from the Fed this month to be along the lines of what New York Fed President John Williams shared on Thursday: “This is an unusual set of circumstances, but the current stance of monetary policy is well positioned to balance the risks to our maximum employment and price stability goals.”4

Timing Question

The 19-member Federal Open Market Committee will discuss the wide variety of scenarios ahead when they meet at the end of the month.

“I’m not taking anything off the table,” said Goolsbee, the Chicago Fed president.

He said he’d entered the year anticipating rate cuts may be justified, assuming the tariff impact did indeed fade. But the energy shock “pushes it out the longer this goes,” he said.

Fed Governor Stephen Miran, a former top economic adviser to President Donald Trump who’s been more dovish than his peers, said he’s still anticipating a few rate cuts this year. The energy shock has “increased the risks of higher inflation further out,” he said, but it’s not clear yet that it’ll drastically change the trajectory prices had been on this year.

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He flagged that rental prices, a major contributor to inflation data, had been declining. There was also some “statistical noise” keeping inflation elevated, he said, such as higher stock prices driving up portfolio management fees.

Since the Fed’s rate policies take a while to take effect, the question is whether the shock will prove longer lasting, he said. And monitoring how inflation expectations evolve will be critical, he said.

“For monetary policy to respond today to an energy shock over the next few months, you have to believe that prices are moving higher, not now, not in the next few months, but 12 to 18 months from now,” Miran said.

Other Fed officials are a bit more wary about the inflation picture.

The Fed has been “missing on our inflation target for five years,” Cleveland President Beth Hammack told CNBC this week.5 That means that a person spending $100 at the grocery store five years ago is now spending $120—not $110 if inflation had stayed at the Fed’s 2% target.

The job market appears “reasonably in balance,” but the Fed is “persistently missing on the inflation side” of its dual mandate, she said. The Fed should thus start saying that rates could go either way, she argued, rather than sticking with its current bias of cutting.

Not that she sees a hike anytime soon.

“Rates are in a good place,” she said. “My baseline is that we’re going to remain on hold for a good while.”

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1. Youtube. "Semafor World Economy 2026."
2. Board of Governors of the Federal Reserve System. “Speech by Governor Christopher J. Waller, April 17, 2026.”
3. International Energy Agency. “Oil Market Report - April 2026.”
4. Federal Reserve Bank of New York. “Speech by John C. Williams, April 16, 2026.”
5. National Broadcasting Company. “Cleveland Fed President Hammack Expects Interest Rates to Stay on Hold for a Good While.”

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