A (2:30)

Obviously, energy, oil, those are all inputs that matter for production, for service producing businesses. And so if you start to see inflationary pressures sort of broaden beyond the energy sector itself into other parts of the economy, that I think would be of concern to Fed policy policymakers but they will also then be watching the real side of the economy. Does the spike in oil prices then have negative implications for growth, which then trickles over to the labor market? Do we start to see job losses? Do we start to see consumers pull back? Do we start to see businesses pull back?

E (3:02)

If we start to answer yes to those questions, the Fed's dual mandate of keeping prices stable and promoting maximum employment gets a lot trickier. The tools it has to address inflation, like raising interest rates, could make the labor market worse. And lowering rates to address unemployment could lead to higher inflation. Wharton Associate Professor Peter Conti Brown puts

D (3:23)

it more simply, in so many respects, this is the Fed's worst nightmare.

E (3:31)

I'm David Gura and this is the big take from Bloomberg News today on the show how the Fed is thinking about the Iran war, why it held rates steady, and what could shift its calculus the months ahead. The part of the Federal Reserve that sets interest rates is called the Federal Open Market Committee. Those policymakers have a tough job under normal economic conditions. They have to predict where they think the economy is going by looking largely at data that show where it's been. And in the last few weeks, with the start of the Iran war, predicting where the economy is heading has gotten much, much harder. To understand how the Fed is approaching this challenging time, I talked to Bloomberg Fed reporter Amera Amokwe and Wharton Professor Peter Conti Brown, who's a Fed historian. For starters, I asked Amera what factors the policymakers considered as they decided where interest rates should be right now.

A (4:27)

There was a pre Iran war perspective and the situation has obviously shifted dramatically now that we have the conflict in Iran. So after the last meeting in January, you got the sense that Fed officials broadly agreed that they had policy in a good place. They cut three times towards the end of 2025. The labor market appeared to be steadying after jitters earlier in 2025, and they didn't cut in January. And you heard Chair Jerome Powell and several other policymakers saying they thought policy was in a good place. And some of them were really expressing concerns about the fact that inflation remains above the Fed's target and that it has been above target for five years now. Then the US And Israel launched this war on Iran. And that has really kind of scrambled the outlook and raises a lot of questions about how the Fed will proceed in months ahead. If we start to see their policy goals promoting maximum employment and bringing inflation back down start to come into conflict because we have seen oil prices shoot sharply higher, that has potential implications for inflation, it also has potential implications for economic growth in the labor market. And so the question now for the Fed is if this energy shock that we're seeing now persists, how might they approach that?

E (5:45)

Peter, the policymakers are looking at this famous dashboard, looking at all of these economic data points, and so many of them came before Israel and the US launched that war. How does that complicate what America's talking about? Their ability to kind of figure out where the economy is and where it's going.

D (6:01)

Should the Iran war be temporary, should the Strait of Hormuz and the rapid deterioration of vessel flow through that straight and be relatively short lived, then this presents a very challenging dynamic for the Fed to navigate. But it knows how to do this. Should that be prolonged, it's not just very challenging. This becomes the impossibility theorem. This is stagflation. This is you don't know which lever to pull because you exacerbate either one of your two new mandates. And so when you have all of the dashboard lights flashing rainbow colors because you don't know exactly where we will be four weeks from now, let alone four months from now, then this creates just an unbelievably difficult trajectory. Add to that what Amer was saying is that we have not reached disinflation to target. Right? So this level of uncertainty makes policy making in any given FOMC meeting playing darts with a blindfold. The Fed is going to be exceedingly unlikely to sprint into the breach to wave off a recession. If inflation is moving up even incrementally, if it's moving up quickly, then I think it's inconceivable for the Fed to prioritize unemployment over an inflationary spiral.

E (7:16)

Peter, you're a Fed historian, and I'm curious what analogs you're looking to at this moment. So there is all of this uncertainty over what the Fed is doing right now, what it's going to be doing at subsequent meetings. And is there a parallel that you reach for to this moment?

D (7:30)

Yeah, there are two. There's the oil shock of 1973. It's important to remember that the context there. So we had an oil embargo announced by OPEC led by Saudi Arabia. Inflation was already at about 9% at the time, so it was a different inflationary environment than we have today. But that oil embargo had unbelievable effects. And so it exacerbated the inflationary context while recessionary consequences were also ticking up. This leads into just an unbelievably bruising decade of Fed policy Wherein to finally slay the dragon of inflation, Paul Volcker's FOMC had to trigger a recession so profound it was getting close to Great Depression territory. And indeed, until the Great Recession, it was the most acute recession that we had experienced since the 1930s. So that's the bad historical analog. The better one would be the late 40s and early 50s. This is the time when the Fed separated itself from under the Treasury's domain to assert for itself more independence and setting interest rate trajectories at a time when inflation looked like it was going to have a post war pop that would be very hard to eradicate. But that never happened. It never took root. And as a result, we had just extraordinary economic growth with relatively mild inflation. So we want things to look like the 50s. We fear that things are looking like the 70s.

E (8:51)

Amera, as you listened to Fed policymakers in the run up to this meeting, how much was that history coloring their sense of this moment? How evident was it that they were thinking back about those two instances that Peter just mentioned?

A (9:02)

So we didn't hear from many Fed policymakers after the launch of the war. We heard from a few, like a handful, talking about sort of this textbook approach to oil shocks, to energy shocks, which would say that if the shock is a short term thing, the Fed should look through it. In other words, the Fed doesn't necessarily need to raise rates because the Fed is thinking about policy on a medium to long term outlook. And so if something is going to be short lived, you don't want to overreact to that and set policy according to that.

E (9:33)

What does it mean for the Fed to look through something when we use

D (9:37)

the metaphor of looking through? And it is a metaphor, you're saying, because you're saying there's some sort of tumult in front of you that you can see the end of, you can see the other side of. And the other side looks more like where we were before the tunnel than it does in the tunnel. Because if the tumult is the new normal, then there's no looking through. You have to adjust to the new normal. And that's what the Fed doesn't have the luxury of doing. Are we going to see, as a result of whatever is happening in the Middle east today, a fundamental reordering of the way that we do geopolitics, energy policy, macroeconomic growth alliances? And if the answer to that is yes, there's no looking through, the tumult is us. And that's what the Fed has to adapt to.

E (10:13)

Peter, I'M curious how the Fed is trying to encourage stability in the bond market at this moment. I mean, there's been so much volatility as a result of this war getting underway. What are policymakers trying to do to kind of calm things down so much as they can?

D (10:27)

I think this is one of the reasons why this is kind of a nightmare scenario. The Fed's primary tools for calming bond markets is to assure the markets of its medium and long term credibility, that no matter what happens in the world, whether we have to look through these episodic supply shocks or whether we incorporate them into our diagnosis and prognosis, the Fed will be grown ups in the room to do the right thing for the long term stability of the US dollar. And those are assurances that are very difficult to make when what we're trying to predict is whether this is going to be an inflationary environment, not just because of the Iran war, but because the deterioration of norms of Fed independence, or this is going to be a recessionary environment. We haven't talked about the other elephant in the room, which is whether AI will be riding us the economy on a rocket toward greater productivity rate compression or the white collar recession that will send unemployment rates into double digits. And given that amount of uncertainty, the only thing that the Fed can do to reassure bond markets is to continue to say we don't know what the right policy is, except we do know that we will find it.

E (11:37)

Coming up, the challenges facing the Federal Reserve as it tries to find the right policy in the face of attacks on its independence and dissent among policymakers. And the latest developments as Jerome Powell reaches the end of his term as chair in the midst of a DOJ investigation into him and the Fed.

B (11:56)

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E (14:43)

Peter Looking at the crucible of the FOMC and thinking about history, do moments like this tend to lead to more unanimity among policymakers or more division? We went through this period where it seemed like Fed Chair Jerome Powell had a lot of success in getting members of that committee to come on board with what he hoped the committee would do. We've seen that erode a bit in recent meetings. Is this historically a time the Fed is more unified when there is a large geopolitical risk like this one?

D (15:11)

You know, in the cycles of history, of division and unanimity and consensus on the political side, we have enough data points to really see cycles. But at the Fed we don't. And the reason is because we simply don't have the tradition of a lot of desensus at the fomc, at least formally, as tallied by votes. And in that sense, this is another factor that makes the current FOMC extraordinarily difficult to predict. And that's because not because we have 10 central bankers who see it one way and two who see it another. That's pretty consistent over time. It's that we have the famous double dissents that we have not seen for many years. What that means for those who are kind of outside that Fed speak universe is that we have the consensus view, that's the policy view that commands the majority of the ofomc, and then we have dissents going in both other directions. So saying you're being too restrictive, say one group, and you're being too accommodative, says another. And that's what we have right now, although not in the January meeting, but in the meetings prior, we had double dissents. And that makes it really hard to predict what the Iran policy will mean for the fomc. Unlike in a political context where sometimes we have these external wars creating a rally around the flag moment, there's not that same ethos because the questions are fundamentally different.

E (16:28)

Amira, we started off with you talking about how much has changed here over these last few weeks. And I look at this note, a recent note from Deutsche bank, and that economics team writes a question that was almost unthinkable two weeks ago is now being more heavily debated. Could the Fed raise rates in 2026? You talked about how the economy has shifted, the forecast for the economy have changed. How about just in terms of what market participants are expecting the Fed to do in the weeks and months ahead?

A (16:53)

I think people are not really expecting another cut under Chair Powell, whose term ends in May. But I think it's interesting because even if you look at the minutes from the January meeting, there were some officials who were already talking about hikes then, who were saying, look, inflation has been too high for too long, and we actually need to adjust what we're saying about the situation to acknowledge the fact that moves in the future may need to be higher. And so for those, as Peter was talking about, those policymakers who are more concerned about inflation, you could see a world where this Iran situation, if it continues, could only heighten their concerns and maybe make them have less of an appetite to respond to any downsides that we see on the real side of the economy, you know, for economic growth, for the labor market, because there are new inflationary pressures. And so I think what markets and investors are going to be listening closely for in this meeting and in subsequent meetings if this situation continues, is how Chair Powell is sort of characterizing the vibe on the committee and how he's really thinking about balancing these two risks in the months ahead. And that matters also because as it stands now, Chair Powell could perhaps still be on the board even past his chair term in May, and he could still be chairing the FOMC past his chair term in May. And so I think people are still going to be looking for some signal from Chair Powell in these final meetings under his chair term.

E (18:15)

Right. So, Peter, Jerome Powell's tenure as Fed Chair is supposed to end this spring, but he told reporters today that if his successor is not confirmed by the end of his term and he would serve as chair pro tem until then. Powell also told reporters he wouldn't leave the Fed board while a Department of justice investigation into him and the Federal Reserve is ongoing. And all of this relates to a renovation project of the Federal Reserve's headquarters and testimony that Jay Powell gave about that renovation a few days ago. A judge blocked subpoenas that were a part of that investigation. And the DOJ has vowed to appeal that. How could all of this, that legal fight, influence the way the Fed is handling decisions going forward and how the confirmation process for Powell's successor plays out?

D (18:57)

I think the announcement that the Department of Justice is going to appeal the legal decision from the district Court increased my priors from I think that there was a substantial minority probability that Chair Powell would continue on as governor to now thinking that it is likelier than not that Chair Powell is not going anywhere. And because Thom Tillis, senator from North Carolina, has stayed resolute in his determination that so long as criminal proceedings are open against Jay Powell, there will be no confirmation hearing for his successor. But we also heard something that was from the lawyers representing Jay Powell, which they told the Department of Justice that so long as this investigation is pending, Jay Powell's not going anywhere. He will be staying at the Fed. And as now, putting on my legal hat, I would say that is, if I were asked for legal advice from the Palatine, that's exactly what I would tell them. You'd go nowhere. You stay exactly where you are. You put yourself in expanded legal and criminal peril should you leave. And so you stay where you are. You continue to be represented by the Fed's lawyers. You continue to exercise that political coalition that's going to be plugged into the Fed. And if that's true, that scrambles the governance story by a lot. And that means not only are we likely to have Jay Palestine in place, we are also likely for the first time in the Fed's history, to have, you know, an Avignon Pope, two Popes at the Fed, two chairs. Meaning that as soon as his term is up as Fed Chair, it is likely to be the case that Vice Chair Jefferson will take over for those board duties. But the fomc, which elects its chair on an annual basis, will keep Powell in place until his successor is named. Indeed, that is what they announced in January when they held that election. And so we will have a Fed Chair, Jay Powell of the fomc, and we will have a Fed Chair, Philip Jefferson at the board, and we will have a raging president who doesn't like either of them and wants to do something. A third thing, and my only advice to Fed watchers everywhere is grab your tissues and grab your bucket of popcorn. Because this tragicomedy is just, you know, beginning.

E (21:05)

This is the Big Take from Bloomberg News. I'm David Gura. To get more From from the Big Take and unlimited access to all of Bloomberg.com, subscribe today at Bloomberg.com podcastoffer if you like this episode, make sure to follow and review the Big Take. Wherever you listen to podcasts, it helps people find the show. Thanks for listening. We'll be back tomorrow.

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