The Rate Cut Dilemma: What Should the Fed Do Amid a Geopolitical Crisis?

Trump is demanding that Powell cut interest rates as the Iran conflict drives up energy prices. The logic—lower rates to cushion consumers from oil shock—makes surface-level sense. But history shows the consequences of that playbook are far from straightforward.

Trump's Demand and Its Logic

President Trump is pressuring Fed Chair Powell to cut rates as energy prices soar amid the Iran conflict.

On the surface, it tracks. Surging oil and gasoline prices hit consumers directly. Cutting rates reduces borrowing costs and stimulates the economy, potentially acting as a buffer against energy-driven growth threats.

But there's a critical blind spot.

Rate cuts are fundamentally about injecting money into the system. That's inherently inflationary. Layer supply-side inflation from rising oil prices on top, and you've got a combination that has historically produced devastating outcomes.

Greenspan's Post-9/11 Rate Cuts: The Historical Lesson

Alan Greenspan left us the definitive case study on cutting rates into a geopolitical shock. Following the September 11, 2001 terrorist attacks, the Fed made an emergency 50 basis point cut on September 17th.

Several more cuts followed, eventually driving rates to a historic low of 1%.

What happened next?

Short-term, it worked. Markets stabilized. The fear-stricken economy got breathing room. But economists from the Cato Institute and numerous market analysts argue that maintaining 1% rates for an extended period fueled:

• The housing bubble — cheap credit drove real estate speculation, directly causing the 2008 financial crisis
• Commodity price spikes — excess liquidity flowed into commodity markets
• Financial risk accumulation — the low-rate environment encouraged excessive leverage and risk-seeking behavior

Low CPI readings and productivity gains during Greenspan's tenure masked the problem at the consumer price level, but asset price inflation was quietly building into a time bomb.

The 2026 Economy: Why It's More Dangerous Now

Today's environment is qualitatively different from 2001.

2001:

• Inflation was stable
• Ample room for rate cuts
• Supply shock was temporary (attack → recovery)

2026:

• Inflation already stubbornly sticky
• 2-year Treasury yields surging in response to oil prices
• Supply shock potentially sustained (prolonged Hormuz blockade)
• Labor market already cooling

This morning's year-over-year PCE reading came in relatively neutral—not terrible, but not encouraging either. With inflation still not fully tamed, cutting rates risks pouring fuel on a fire that's already burning.

The Warning Signal from 2-Year Yields

The 2-year Treasury yield deserves particular attention. It's screaming higher in response to oil prices, and the message is clear: the market expects inflation to remain sticky.

This surge is pushing back rate cut probabilities. It's a hawkish signal, and in my assessment, it's the correct one.

If you cut rates and flood the system with liquidity while oil prices are already surging, you get hit with a double dose of inflation—supply-driven from energy and demand-driven from monetary easing.

The Fed's Options

Let me be direct: the Fed is in a position where every option carries pain.

Cut rates:

• Short-term relief on borrowing costs for consumers and businesses
• But risks igniting inflation expectations, potentially spiraling with oil price pressures
• Could plant the seeds of a 2008-style asset bubble

Hold rates steady:

• Helps contain inflation expectations
• But adds pressure to an economy already absorbing energy price shocks
• Labor market cooling could accelerate

My view is clear: this is not the time to cut. Sticky inflation, already-surging Treasury yields, and the inflationary effects of rising oil prices all coexist right now. A rate cut might deliver short-term relief, but the medium-to-long-term consequences would likely be far worse.

As Greenspan's example demonstrates, crisis-driven rate cuts can stabilize markets in the moment, but the bill often comes due years later at a much larger scale.

FAQ

Q: Won't a recession hit if the Fed doesn't cut rates? A: It's possible. An energy price shock combined with high rates could slow growth. But if cutting rates triggers an inflation spiral, the subsequent recession would be far deeper and longer. The 1970s stagflation is the cautionary tale.

Q: Was Greenspan's rate cut really the cause of the 2008 crisis? A: It wasn't the sole cause, but most economists consider it a key contributing factor. Extended ultra-low rates encouraged excessive risk-taking and fueled the housing market bubble.

Q: If PCE data came in neutral, isn't there room to cut? A: Looking at PCE alone, perhaps. But the 2-year Treasury yield surging signals the market sees greater inflation risk ahead. A single data point matters less than the full picture.