The balance of risks in Federal Reserve interest rate policy seems to be shifting towards an emphasis on “firmer inflation rather than weaker hiring,” as noted by analysts. In a note on Friday, the strategists including Michael Gapen and Sam Coffin indicated that any sustained disinflation in the future hinges on the resolution of the joint U.S.-Israeli assault on Iran, particularly as upward pressure from extensive tariffs implemented during the Trump administration appears to be “nearing completion.” Data this week indicated that headline consumer price growth accelerated at its fastest pace in years in May, while hotter producer price gains contributed to an uptick in estimates for the Fed’s preferred inflation gauge, the core personal consumption price index. Driving these figures were energy prices, which have surged since the onset of the Iran war in late February, primarily due to the prolonged closure of the Strait of Hormuz, a crucial passage for the global supply of oil and liquefied natural gas.

The labour market has continued to strengthen despite the ongoing conflict, thereby reducing downside risks to the Federal Reserve’s policy outlook, as noted by analysts at Morgan Stanley. In theory, interest rate increases implemented by the Federal Reserve can assist in controlling inflation; however, they may also exert pressure on the broader economy, including the labour market. Markets are currently projecting that the Federal Reserve will maintain its current interest rates following the conclusion of its two-day policy meeting next week, despite expectations that the central bank may increase borrowing costs before the year’s end. Simultaneously, the anticipation at the outset of 2026 regarding the Fed initiating a rate-cutting cycle has waned. Underlying these bets is the conviction that the Federal Reserve might choose to focus on inflation, especially in light of indications that the U.S. labour market remains strong.

The Morgan Stanley analysts outlined two scenarios in which inflation could remain elevated, leading the Fed to either maintain its current stance for an extended period or consider increasing rates. The first scenario involves a “demand push,” characterised by heightened consumption and business investment that drive a resurgence in growth and tighter labour market conditions. The second scenario is marked by a sustained oil premium resulting from an extended U.S.-Iran conflict. “The recent developments in the Middle East, together with last week’s employment report and this week’s inflation data, suggest that both scenarios may be becoming more likely than we initially anticipated,” according to their analysis. “On net, the data indicate that the balance of risks is shifting in the direction of firmer inflation over weak hiring.” Still, there are expectations that a U.S.-Iran peace agreement could be imminent.

On Friday, Iranian state media conveyed that a proposed peace agreement between the U.S. and Iran would entail a commitment from Tehran to reopen the Strait of Hormuz, alongside a pledge from Washington to lift oil sanctions. Iran’s Mehr news agency reported that a Memorandum of Understanding with the U.S. would encompass the release of frozen Iranian funds, noting that concluding negotiations will center on nuclear and economic matters. However, discussions regarding Iran’s missile program will be omitted, as reported. Brent crude futures, the global oil benchmark, experienced a decline. On Thursday, the contract declined beneath $90 a barrel following U.S. President Donald Trump’s indication that a resolution to the ongoing conflict in Iran, which has persisted for four months, might be reached as early as this weekend.