Federal Reserve Chair Jerome Powell delivered a clear policy signal during a Harvard University economics class, stating that the Fed will not raise interest rates in response to inflation caused by the Iran war’s oil shock. Powell emphasized that the current Fed funds rate of 3.50%–3.75% remains appropriate, as oil shocks are temporary and rate hikes are ineffective against supply-side disruptions. This announcement led to a sharp drop in market expectations for a rate hike by December, with odds collapsing from above 50% to just 2.2%. Treasury yields fell by 10 basis points across the curve, the U.S. dollar softened, and gold prices firmed [1]. Powell stated, 'We feel like our policy is in a good place for us to wait and see how that turns out,' reinforcing the Fed's wait-and-see approach [1].
Oil prices, which had surged due to the conflict, reversed course following reports that U.S. President Donald Trump is willing to end the military campaign against Iran even if the Strait of Hormuz remains largely closed. West Texas Intermediate (WTI) futures dropped over 3% to near $98.00 per barrel [4], while Brent crude fell 1% to $111.55 per barrel [6]. The Wall Street Journal reported that Trump’s willingness to accept a truce without reopening the Strait of Hormuz eased global energy supply concerns and anchored inflation expectations, though restoration of Gulf energy infrastructure is expected to take months [4][6]. Trump also threatened to escalate attacks on Iran’s energy infrastructure if a deal is not reached soon, adding uncertainty to the outlook [2][6].
The US Dollar Index (DXY) retreated from its year-to-date peak, trading below 100.50, as risk sentiment improved and oil prices corrected. The USD was down less than 0.10% for the day, with the strongest performance against the New Zealand Dollar [2]. However, ongoing troop deployments and Iran’s reluctance to negotiate directly with the US maintain uncertainty about a quick de-escalation [2][3][5][6]. The Canadian Dollar (CAD) remained weaker as oil prices slipped, with USD/CAD trading around 1.3930 [3]. The New Zealand Dollar (NZD) gained ground as the USD lost strength, but safe-haven demand could support the Greenback amid persistent Middle East tensions [5].
Fed officials, including Powell and New York Fed President John Williams, reiterated that long-term US inflation expectations are well anchored and that monetary policy is well-positioned for unusual circumstances. Williams noted that the job market is still sending mixed signals [3][5]. Analyst Matt Gertken described Trump’s threats as an attempt to 'retract and conclude a deal,' but warned that escalation could target Iran’s core regime elements and energy infrastructure, leading to higher collateral damage [6]. Ben Emons highlighted renewed risks to energy flows following Iran’s attack on a Kuwaiti oil tanker near Dubai [6].
According to [1], the Fed’s decision to 'look through' the oil shock is based on the view that supply-side inflation does not warrant rate hikes, while [2][4][6] report that Trump’s shifting stance on Iran is driving volatility in oil and currency markets. The restoration of Gulf energy infrastructure is expected to take months, keeping supply limited for a while [4].
CONCLUSION
The Federal Reserve’s decision to maintain rates and 'look through' the oil shock, combined with President Trump’s signals of a possible truce with Iran, has led to a sharp reversal in oil prices and softened the US dollar. While risk sentiment has improved, ongoing geopolitical tensions and threats of escalation continue to pose risks to global energy flows and market stability. Investors should remain cautious as restoration of Gulf infrastructure and diplomatic progress remain uncertain.