The agreement between the United States and Iran to end the war paves the way for the reopening of the Strait of Hormuz , easing the inflationary pressures that the conflict brought to the world and to the United States.
According to Andrew Hollenhorst , chief economist for the United States at Citi, the development should not lead the Federal Reserve (Fed, the American central bank) to accelerate interest rate cuts – much to the frustration of President Donald Trump and the Brazilian Central Bank.
In an interview with NeoFeed , he argues that reopening the Strait of Hormuz only brings a balance between inflation and the labor market, without forcing the price index to reach the 2% target.
“Core inflation remains above target and the labor market is stable. Economic growth also remains strong, supported by AI and resilient consumption. Given these factors, it does not appear to be an economy that urgently needs interest rate cuts,” he states.
The resilience of consumption even managed to overcome the effects of tariffs and the rise in oil prices. For Hollenhorst, one explanation lies in the fact that many Americans benefited from the impacts of AI on the stock market.
He points out, however, that if this scenario is reversed, the United States could be heading towards a situation similar to that experienced in 2000, when the dot-com bubble occurred.
In the interview, Hollenhorst also revisits a topic he raised three years ago: the possibility of the United States abandoning its 2% inflation target . He believes this is an issue that shouldn't prosper. But the Fed needs to indicate how it will adopt a more holistic view of inflation.
Read below the main excerpts from the interview:
Andrew Hollenhorst, Chief Economist for the United States at Citi
What is your opinion on the ceasefire agreement? Does it ease inflation and change expectations regarding the Fed?
This agreement is relevant to the United States and the global economy. But two aspects are interesting in relation to what was perhaps expected a few months ago. First, oil prices never reached the levels many feared. There was a sharp rise, but the extreme scenarios never materialized. This meant less inflationary pressure. Second, the American economy demonstrated resilience. Household consumption remained strong. A few months ago, many feared a stagflationary shock. Instead, we observed something more moderate. It did not cause a radical change in economic forecasts.
So what can we expect from this agreement?
If the reopening of the Strait of Hormuz occurs as expected, this reduces the risk of an inflationary surprise. The oil flow may even generate oversupply, since there has been a reduction in demand and other sources of supply have entered the market. This could drive down oil and gasoline prices. But, in my assessment, the recent employment report had an even greater impact than the recent events related to oil.
"If the reopening of the Strait of Hormuz occurs as expected, this reduces the risk of an inflationary surprise."
Like this?
At the beginning of the year, job growth seemed very weak. Average wage growth was practically zero, and the unemployment rate was rising. At the same time, inflation appeared to be slowing. In recent months, the balance of risks has shifted. Previously, the risk was a worsening labor market. Now, employment has ceased to be a concern for many Fed officials, while inflation has taken center stage. With the reopening of the Strait of Hormuz, the inflationary risk may fall again, leaving the Fed more comfortable with the balance between inflation and the labor market.
What does this mean in terms of monetary policy? Will Trump get what he wants, the interest rate cuts? Or does the Fed still need to act cautiously?
It's very difficult to justify interest rate cuts. Core inflation remains above target and the labor market is stable. Economic growth also remains strong, supported by AI and resilient consumption. Given these factors, it doesn't seem like an economy that urgently needs interest rate cuts; I don't think Waller will pursue that. This doesn't mean cuts are ruled out. For them to occur, it would be necessary to observe more evidence of slowing inflation, lower oil prices, and a weakening labor market.
Do you foresee interest rate cuts? If so, by how much?
Our base-case scenario anticipates a return to cuts in September, but this depends on labor market data. Currently, our base-case scenario is for reductions of 0.25 percentage points in September, October, and December. However, we are most confident that cuts will eventually happen, with the exact timing depending on how economic data evolves. Depending on how it turns out, the cuts could be postponed until next year. The exact timing is difficult to pinpoint.
"Our base-case scenario anticipates a return to cuts in September, but this depends on labor market data."
Three years ago we discussed the possibility of raising the inflation target to something close to 3%. Is this discussion still relevant?
Yes, it remains relevant, but it's a difficult discussion for monetary policymakers. As long as inflation is above target and central banks continue to fail to meet it, officially changing the target would compromise the institution's credibility. If it were possible to start from scratch, perhaps it would be more reasonable to work with a range, something like 1.5% to 3%, instead of a rigid 2% target.
Can you give an example?
From an economic standpoint, there isn't a significant difference between a stable inflation rate of 1.75% and one of 2.5%. The problem is that, after years above the target, any change could be interpreted as an attempt to accommodate the failure to control inflation. Therefore, I don't believe we will see a formal change in the target. What is more likely is that the Fed will begin to consider a wider range of inflation indicators, instead of relying excessively on the PCE index.
How would you assess the current state of the American economy? How much of that performance comes from investments in AI? And is AI benefiting other sectors?
Today, AI is a central part of economic projections. When we analyze investments in data centers, electronics, and AI-related infrastructure, we conclude that approximately half of GDP growth is coming from this sector. The other half comes from household consumption. The difference is that consumption generates widely distributed benefits. When people frequent restaurants, they create jobs, boost suppliers, and stimulate various sectors. AI generates growth, but it is much more concentrated. Furthermore, it is highly dependent on investor enthusiasm. If this sentiment changes, investments may slow down, becoming a negative factor for growth.
"When we analyze investments in data centers, electronics, and AI-related infrastructure, we conclude that approximately half of GDP growth is coming from this sector."
Did import tariffs have a significant impact on consumption and the economy?
The impact was quite limited. There was some increase in the prices of imported goods, but nothing close to what many feared. This slightly reduced consumers' purchasing power and slowed spending somewhat. But the effect was relatively small. The same occurred with energy prices. Low-income families were more affected by fuel price increases, but, looking at the economy as a whole, the impact was not enough to cause a sharp drop in consumption.
It's curious how resilient consumption is. It seems people have managed to adapt to the inflationary scenario…
One factor helping to sustain aggregate consumption, though not equally for everyone, is that while prices have been rising, the prices of financial assets have been rising even faster. This is very important. Families who own assets in stocks or real estate felt wealthier and continued to consume. This sustains growth. On the other hand, there is a risk. If there is a negative reassessment of the enthusiasm surrounding AI and stock markets fall, these consumers may reduce their spending. This would be a scenario similar to the early 2000s.
How concerned should we be about the United States' deficit?
I don't see financial markets worried about an immediate risk. The United States has been dealing with high deficits and a high debt-to-GDP ratio for many years. Throughout my professional life, I've heard predictions of an American debt crisis that never materialized. But that doesn't mean the problem doesn't exist. Deficits of 6% or 7% of GDP are not sustainable in the long term. At some point, it will be necessary to increase revenue, reduce spending, or accelerate economic growth.
And the dollar? Is the trend still one of weakening?
There are forces acting in opposing directions. On the one hand, US economic growth remains strong. This would normally favor a stronger dollar. On the other hand, the Fed is unlikely to raise interest rates and may even lower them. Meanwhile, other central banks have been adopting more restrictive monetary policies. This interest rate differential tends to weaken the dollar. Therefore, our current view is neutral. Economic fundamentals suggest a strong dollar, but interest rate differentials point in the opposite direction.
