The conflict between the US and Iran is hitting the core of the Federal Reserve’s rate strategy. The one factor that was keeping rate cuts alive, falling housing costs, is now under pressure.
Until recently, the housing market was working in the Fed’s favour. Rents were easing, mortgage rates were coming down, and that opened the door to rate cuts. The attack on Iran is now threatening to reverse that trend, just as parts of the US economy are in urgent need of relief.
With US inflation expected at around 4.2 percent this year, according to the OECD, the debate inside the Fed has narrowed to one question: will housing costs fall fast enough to offset the inflationary impact of higher oil prices? The answer will determine whether rate cuts happen at all.
“A lot of my inflation outlook is predicated on housing disinflation,” said Federal Reserve governor Stephen Miran, speaking to Investment Officer on the sidelines of the Digital Asset Summit in New York. “If we saw something that convinced me that housing disinflation wasn’t coming through in the magnitude needed, then I’d change my mind. Housing is the single biggest expense for most families.”
Miran, appointed by President Trump and known as a supporter of lower rates, now sees his key assumption coming under pressure.
Mortgage rates, which track US government bond yields, rose by about 50 basis points last month to 6.5 percent. Higher energy prices are pushing rates higher and weakening the disinflationary trend the Fed has been relying on.
That has immediate consequences for affordability. Before the conflict, mortgage rates were falling, house price growth was slowing, and more homes were coming onto the market. That improvement now risks stalling.
“If we saw something that convinced me that housing disinflation wasn’t coming through in the magnitude needed, then I’d change my mind.”
Stephen Miran, Federal Reserve
Writing in February, Pimco economist Tiffany Wilding argued that the worst of housing inflation was over, and that rental costs were heading not just back to normal but “well below” pre-pandemic levels, a trend she said would give the Fed space to continue cutting rates.
Market expectations for Fed rates have shifted in recent weeks. According to the CME FedWatch tool, the single most likely outcome today, with around 50 percent probability, is no cuts at all, with a further 36 percent chance of rates actually rising. A month ago, traders were pricing in two to three rate cuts by December.
Federal Reserve chair Jerome Powell this week pushed back against expectations that the central bank will need to respond quickly to the recent rise in energy prices. Speaking at Harvard University, he said longer-term inflation expectations remain “well anchored,” meaning there is no immediate need to raise interest rates. He sees the current target range of 3.5 to 3.75 percent as “a good place” to wait and assess how events unfold.
Miran nonetheless thinks interest rates are currently still about 100 basispoints above the neutral rate.
“We need to set policy for a year to a year and a half out, oil moving higher now has very little inflationary consequence 12 to 18 months out, all the inflation happens up front,” he said.
Delay now, cut more later
For millions of American households, housing is the clearest symbol of how far financial conditions have drifted out of reach. That makes Miran’s inflation framework and the economic pain felt by lower-income households two sides of the same problem. The Iran shock now threatens both at once.
The risk, warns Valentine Ainouz, head of global fixed income at Amundi, runs deeper than a delayed recovery. “Central banks will not only delay rate cuts, but will have, at a later stage, to cut rates by more than currently expected,” she said.
Such a scenario would mark a significant policy miscalculation, she said. The parts of the economy most dependent on lower rates, small businesses, lower-income households and a frozen housing market, would bear the cost of waiting. And the eventual cuts, when they came, would arrive not as a controlled easing but as a response to damage already done.
The risk for the Federal Reserve is that it is anchoring its policy outlook to a housing market that is no longer behaving in a stable or predictable way. Existing home sales are already running roughly 25 percent below 2019 levels and sit near their lowest point since 1995, while rising mortgage rates driven by the Iran conflict are again pushing buyers to the sidelines and stalling what had been a fragile recovery.
For governor Stephen Miran, whose outlook hinges on housing disinflation, that creates a growing tension: the very sector he is counting on to bring inflation down is becoming weaker and more unstable.