John Williams said it is not yet possible to know how the Iran war will affect the US economy. He said US monetary policy remains well positioned for an uncertain economy.
He said risks to both sides of the Fed’s mandates have increased and the economy is facing an unusual set of circumstances. He described the market energy outlook as benign, while noting plausible negative scenarios.
Iran War Uncertainty And Oil Shock Hedges
He said inflation is likely to be 3% this year and return to the 2% target in 2027. He said tariffs and energy are major drivers of inflation, while underlying inflation is mostly stable, and tariff-based inflation should ease.
He said notable supply chain disruptions are emerging. He said it is encouraging that inflation expectations remain contained and that the Fed’s job is to keep them steady.
He expects US economic growth of between 2% and 2.25% this year. He expects the jobless rate to stay around 4.25% to 4.50%, and said the job market is holding up well.
He said labour force growth has shifted, and job market break-even may now be between 0 and 50,000 jobs a month. He said R-star is likely higher than recent low readings, and that 3% is likely the long-run Fed funds rate.
Trading Implications For Rates Inflation And Volatility
We are facing a period of high uncertainty, driven by the unknown economic effects of the Iran war. With plausible worst-case scenarios for energy markets, traders should consider hedging against oil price shocks. WTI crude has already seen volatility, recently trading over $95 a barrel, and options strategies that profit from sharp upward moves seem prudent.
Inflation is proving stubborn, with the latest CPI report for April showing a 3.4% annual increase, making the forecast of 3% for this year feel realistic. The path back to the Fed’s 2% target is now seen as a 2027 event, reinforcing a “higher for longer” interest rate environment. This suggests that betting on aggressive rate cuts in the near term is a losing strategy.
The economy remains surprisingly resilient, but cracks are showing in the labor market. While the latest jobs report added a respectable 175,000 positions, the forecast for unemployment to rise towards 4.50% should not be ignored. This divergence between strong growth and a potentially weakening job market creates complex trading signals.
Diverging views within the FOMC are becoming more common, which we also saw during the debates in 2025. This signals that future policy meetings could be volatile, making options that capture volatility around those dates more attractive. We have to accept that the long-run federal funds rate is likely around 3%, a significant shift from the low rates we grew accustomed to.
The re-emergence of supply chain disruptions, combined with tariff impacts, are key inflation risks to monitor. This environment favors long volatility positions, possibly through VIX call options or straddles on major indices. We are seeing that while inflation expectations are holding steady for now, the risks are clearly tilted towards unexpected price spikes.
