Ceasefire with Iran removes recession risk but preserves inflation pressures

Borrowing costs will likely remain elevated for longer as the ceasefire between the United States and Iran removes the most compelling reason for the Federal Reserve to cut rates. The ceasefire eliminates the risk of severe price spikes that would destroy demand and trigger a recession, but it does not remove theinflationary risks associated with the conflict. Energy and commodity prices that rose during the war are unlikely to fully retreat, and financial conditions are easing amid market optimism.

This creates a scenario where energy prices create an echo effect that lingers even after the ceasefire holds. As the probability of a recession declines, the probability of inflation rises because price pressures remain while demand destruction is less severe. The Federal Reserve maintained the benchmark interest rate in the range of 3.5% to 3.75% at its March meeting, marking the second pause following three consecutive rate cuts in the final months of 2025.

Fed officials are weighing dual risks: a sudden deterioration in the labor market that would necessitate rate cuts, or persistently high inflation that would require rate hikes. Minutes from the March 17-18 meeting indicate that progress toward the 2% inflation target has stalled, and the majority of participants believe the risk of inflation remaining persistently above target has increased. Two officials have already postponed their assessment of when rate cuts would be appropriate.

Fed Chair Powell noted that the Federal Reserve is facing its fourth supply shock in recent years following the pandemic, the Russia-Ukraine conflict, and an increase in import tariffs. The Fed is attentive to the risk that inflation expectations become self-fulfilling. Under a framework proposed by former Governor Bernanke, central banks maintain tighter policy when inflation is already above target during a supply shock. Interest rates remain unchanged for prolonged periods.