Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, said it is too soon to know how the Iran war will affect inflation. He said the shock could affect monetary policy, and the Fed needs to see how large and how long it lasts. He said elevated headline inflation needs monitoring given the recent path. He said inflation is still too high but trending down, and the Fed must reach its 2% inflation target.

Monetary Policy And Neutral Rate

Kashkari said he had thought monetary policy was in a good place, but more data are needed to decide what to do with rates this year. He said the strength of the economy points to a higher neutral rate, with near-term AI investment probably pushing it up. He said uncertainty about the tariff outlook has increased. He said he does not think the latest round of tariffs will create fresh inflation, and he does not see much chance of tariffs rising substantially. He said the labour market is in a decent place, but there is not much underlying demand for labour. He said that, before the Iran attack, the Fed’s job and inflation mandates felt more stable. He said he is not hearing much from business about more inflation coming. He said he expects inflation pressures and housing inflation pressures to wane this year, and that March Fed forecasts will show more uncertainty.

Markets Volatility And Positioning

The Fed is signaling that it is now in a reactive, wait-and-see mode because of the conflict in Iran. We should interpret this as a major increase in uncertainty, putting any rate cuts that were previously anticipated on hold. The market is already reflecting this, as fed funds futures have moved to price in less than a 50% chance of a rate cut by mid-year, a steep drop from the 80% probability we saw just weeks ago. This environment means we should prepare for higher volatility across asset classes. The VIX index has already surged from the low teens to over 21 in early March, indicating a sharp rise in market fear. Traders should consider buying protection, such as call options on the VIX or put options on the S&P 500, to hedge against further instability. The most direct impact will be through energy prices, which is the primary inflation risk the Fed is watching. We have already seen Brent crude push past $95 a barrel, up from the low $80s in February, as traders price in supply risk. Long positions in crude oil, through futures or call options, are a direct way to position for an escalation of the conflict. Remembering how the Fed reacted to stubborn inflation throughout 2025, we know their commitment to the 2% target is serious. The headline CPI for January 2026 came in at 2.9%, but the new energy shock threatens the downward trend we had been seeing. This geopolitical event has completely altered the inflation trajectory that seemed to be heading in the right direction. While the labor market is viewed as being in a decent place, the comment about a lack of underlying demand is key. It suggests the economy may not be robust enough to handle a sustained energy price shock without slowing down significantly. This raises the risk of stagflation, a scenario that would put the Fed in a very difficult position and limit its policy options. Create your live VT Markets account and start trading now.

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