Ex-Fed Adviser Flags Israel-Iran Tensions As ‘Wild Card,’ Says Recession Odds Ticking Up

He does not expect the dot-plot curve, which plots the rate outlook of the 10 Fed officials, to show much conviction in either direction

Ahead of a two-day rate-setting meeting that kicks off on Tuesday, a former adviser to central bank chief Jerome Powell, delved into the changing economic outlook in the wake of renewed tensions in the Middle East.

In an interview with MarketWatch, Jon Faust, a fellow at the Center for Financial Economics at Johns Hopkins University, said the market is glued to Powell’s commentary to see whether he acknowledges a greater risk of an inflation outbreak or job market weakening, going forward.

Faust, who also advised Powell’s predecessors Ben Bernanke and Janet Yellen, said, “That’s going to give some indication about what’s happening in policy over the rest of the year.” He added that the Fed hasn’t leaned strongly in either direction.

The economist called the Israeli-Iran conflict a “major wild card” that could spark a downturn.

“To the extent [the conflict] yields a large rise in oil prices and a further shock to uncertainty, and thereby confidence, is the sort of thing that would tip a slowdown,” Faust said.

“Recessions most often happen around some shock that really jolts consumers and businesses. We could be seeing one developing right now in the Mideast. That scenario has become slightly more likely.”

Faust does not expect the dot-plot curve, which plots the rate outlook of the 10 Fed officials, to show much conviction in either direction. As of now, an equal case for “zero” or one or two cuts this year could be made, he said.

He sees the central bank acting only when data supports it, in line with what Powell and most other Fed officials have said recently.

The CME FedWatch Tool, which is constructed based on the futures traders’ rate outlook, now shows that the probability of a pause is at 96.7%. Most futures traders have factored in a cut only by September.

A Stocktwits poll conducted before the May inflation data and the Israeli-Iran tensions showed that most respondents (34%) braced for one cut this year. Those who factored two cuts comprised 27% of the users, while 10% hoped for three or more cuts.

However, a sizable 29% did not expect any cut this year.

Powell is also under political pressure to budge. President Trump has stepped up his call for a one full percentage point rate cut following a surprisingly strong May non-farm payrolls report and tame inflation readings.

The Invesco QQQ Trust (QQQ) ETF and the SPDR S&P 500 ETF (SPY) are up 3.20% and 2.17%, respectively, for the year.

For updates and corrections, email newsroom[at]stocktwits[dot]com.<