Name: On How the Oil Shock and Softening Labor Markets Are Complicating the Fed's Next Move
Uploaded: 2026-03-26T16:48:00Z
Duration: 5 min 11 s
Description: Join us as we discuss the Federal Reserve's next move in the face energy-induced inflation and downside risks to employment from the conflict in the Middle East.

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Join us as we discuss the Federal Reserve's next move in the face energy-induced inflation and downside risks to employment from the conflict in the Middle East.

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On How the Oil Shock and Softening Labor Markets Are Complicating the Fed's Next Move

Thank you. And welcome back, Erik.

Thank you for having me.

Where do we begin? Why don't we start with monetary policy? The Federal Reserve held rates steady last week as expected. Back in December, you posed a question of whether central banks will have to reverse course and tighten again in late 2026. If this Friday's monthly GDP data comes in weak, but inflation stays sticky, does that accelerate your timeline for a potential policy, Fed policy pivot back to hawkishness?

Well, it's a tough question because a weak GDP, but with price stickiness or even evidence of higher inflation really puts the central bank in a dilemma. Do they cut interest rates because growth is weak, or do they raise interest rates or think about maybe tightening because inflation is higher than expected? And we're seeing different responses from different central banks around the world, but when it comes to pivots, I would point out that the Australian Central Bank actually raised rates two times earlier this year. So they're kind of one of the first major central banks to really start tightening policy.

So, Erik, to complicate matters even more, we are three and a half weeks into the Iran war. How will the oil shock impact monetary policy?

Well, I think it just deepens that dilemma. On the one hand, an oil shock for many countries will slow economic growth, especially if they're net oil importers. On the other hand, it will also raise inflation rates all around the world. So do central banks raise interest rates in the face of higher inflation or do they cut interest rates in the face of weaker growth? Different central banks, I think, are coming up with different answers. At the extreme ends, for example, we had the Bank of England, which signaled to the market that they might start raising rates in the face of higher inflation. On the other hand, the Bank of Japan, which have been planning to hike rates, delayed a hike, rate hike, in the face of higher energy prices, which could slow growth.

Let's turn to the labor market, Erik, which remains listless, like it's lacking conviction somehow. Even as job growth is soft, unemployment seems to only be ticking up slightly. What are the risks if the labor market doesn't cool further?

So the labor market, you're right, is very listless in the United States. Over the last year, we've seen only about 150,000 jobs created over 12 months. You know, there's been periods in the past where you had 150,000 jobs created every month, not over 12 months. So it seems like in the US, there's very little hiring going on, but there's also not a lot of mass layoffs. Now, if we were to see a rebound in the labor market and a lot of hiring going on, that would be an argument for the Federal Reserve to pivot towards tighter monetary policy. But we haven't really seen that strength in the labor market in quite some time.

Will an oil tax on consumers suppress wage demands, in your view?

So essentially, higher oil prices are like a tax on consumers. They may actually have the opposite effect. I mean, higher oil prices would be an argument for many employees to go to their employers and say, "Hey, I need a pay hike in order to pay all of this extra money for gasoline." On the other hand, it may make many employers reticent to give pay hikes, especially if higher energy prices are shrinking their profit margins.

And, finally, Erik, we have a heavy treasury auction scheduled this week. Any concerns that the massive US deficit is finally reaching a tipping point? And can private demand continue to absorb the supply without a significant spike in yields?

Well, you know, that private demand is really key because there's no public demand in the marketplace at the moment. So the public demand used to come from quantitative easing, which is now off the table given that inflation rates in the United States and elsewhere are generally running above central bank targets. And then secondly, there's really no expansion of foreign exchange reserves that would get invested into US dollars. So that's one side of the equation. The other side of the equation is what's happening with the deficit. Well, the deficit was already 6% of GDP. The administration has now asked Congress for an additional $200 billion to fund the war effort. And prior to the war breaking out, they asked Congress for an additional half trillion dollars per year in additional defense spending. So a widening deficit will put a lot of burden on the private sector to absorb all of this demand. And when you look abroad, you can see that there's a lot of countries whose rates are already trending higher. That's true in the United Kingdom, in Western Europe, Australia, Canada, and Japan. Treasury yields might eventually join that trend.

Well, Erik, thank you so much. We appreciate your insights as always, and we'll have to leave it here.