Waller: Energy, labor shocks complicate Fed policy path

Federal Reserve Governor Christopher J. Waller highlighted two critical developments reshaping the U.S. economic outlook: the conflict in Iran and significant changes to the labor market's supply side.

The Iran conflict, which began in late February, quickly disrupted Middle East energy production, sending global energy prices soaring.

Gasoline prices have risen by over one-third, with Brent crude reaching $95 per barrel from $61 earlier in the year.

This surge has boosted March headline inflation to an estimated 3.5 percent and core inflation to 3.2 percent, up from 2.8 percent and 3 percent respectively in February.

Simultaneously, net immigration to the U.S. has fallen from 2.3 million in 2024 to minimal levels in 2025 and 2026.

This, combined with an aging population, means near-zero net job creation is now sufficient to absorb new workers, a historically unprecedented development that complicates traditional labor market assessments.

Before the recent shocks, Waller noted that underlying inflation, excluding temporary tariff effects, was running close to the Federal Open Market Committee's (FOMC) 2 percent target.

His primary concern then was a potentially weakening labor market.

However, the dramatic shift in labor force growth, driven by reduced immigration and an aging population, now means that very little or no net job creation is necessary to absorb new workers.

This fundamentally alters how labor market health is assessed, making traditional payroll numbers less reliable as recession indicators.

Waller outlined two scenarios: one where the Strait of Hormuz reopens, leading to falling energy prices and anchored inflation expectations; and another where disruptions continue, keeping energy prices high and potentially leading to more persistent inflation.

He believes markets may be underestimating the risk of prolonged disruptions.