US’s Fed and Pakistan’s dilemma
President Trump’s tariff policy and the Middle East war have made the Federal Reserve’s (Fed) job harder. Energy costs are up, tariffs are still working their way through prices, and inflation refuses to come down to target even as American hiring slows. The Fed is stuck: hold rates high and risk choking off growth further, or ease policy and risk letting inflation take root just as growth…
The Federal Reserve (Fed) faces a challenging situation as it attempts to balance the impacts of President Trump's tariff policy, the ongoing Middle East war, and the persistent issue of inflation. Energy costs have risen, and tariffs continue to work their way into prices, causing inflation to remain above the Fed's 2% target. Meanwhile, the labor market is showing signs of slowing down, making the prospect of another rate hike a significant risk rather than a typical tightening move.
In July, the Federal Open Market Committee voted nine members to hold the rate at 3.50–3.75%, with three members advocating for a quarter-point increase, and none supporting a reduction. Markets now expect rates to stay higher for an extended period due to factors like tariffs, AI-linked investment spending, and Middle East-driven fuel costs, which the Fed believes could make inflation more stubborn than anticipated.
The Fed now finds itself in a predicament, where either cutting rates too soon could allow inflationary pressures to become entrenched, or raising rates while employment is weakening could impose damage on the economy. Keeping rates unchanged might be the most prudent option in the short term, even though markets anticipate a rise in rates as expectations persist that inflation could remain challenging to control due to Trump's tariffs and increased investment in artificial intelligence, compounded by the Middle East conflict driving up fuel prices.
This predicament extends beyond the US, as higher-for-longer rates make dollar assets more attractive, pulling capital away from emerging markets and putting pressure on their currencies. Countries reliant on external financing face a challenging environment with higher borrowing costs, softer export demand, a stronger dollar, and volatile commodity prices.
The Middle East war exacerbates the situation by maintaining elevated energy prices. Despite the progress Pakistan has made in improving its credit rating, prolonged high US rates will keep its borrowing costs elevated. While emerging markets with strong foreign-exchange reserves, deeper domestic capital markets, lower external debt, and large domestic economies have greater resilience to prolonged US monetary tightening, Pakistan finds itself closer to the vulnerable end of the spectrum.
Reserves are still being rebuilt primarily through fresh borrowing rather than exports or foreign investment, and Pakistan's external debt remains heavy. Speakers at the recent Pakistan Banks’ Association conference emphasized that even with credit-rating progress, prolonged high US rates will keep borrowing costs elevated, making it harder for Pakistan to service existing external debt.
If Gulf tensions keep oil elevated simultaneously, Pakistan could be paying more for imported inflation and financing costs. Reserve-building strategies should shift away from rollovers and fresh IMF tranches towards non-debt inflows, such as foreign direct investment (FDI) in export-oriented manufacturing and IT, rather than just portfolio flows chasing high domestic yields.
The more realistic planning assumption for vulnerable emerging economies like Pakistan is a prolonged period of Fed caution rather than a quick pivot either way. This means treating expensive global capital as the baseline for the medium term, rather than a temporary condition to wait out. For Pakistan, this emphasizes the need for stronger reserves, current-account discipline, export growth, and securing longer-term, concessional financing while the window is open. This requires implementing reforms rather than merely making intentions.
Reserve-building must shift away from rollovers and fresh IMF tranches towards non-debt inflows, such as FDI in export-oriented manufacturing and IT, and current-account discipline means resisting import-led growth spurts once GDP picks up, particularly on energy and consumer goods. Export growth requires sustained real depreciation, energy-cost relief for exporters, and market diversification beyond textiles and the EU-US axis.
Financing strategy should prioritize concessional, longer-tenor multilateral debt over expensive commercial borrowing, even if it means slower disbursement.
Written by urgent.news from Dawn Business's reporting — not their text. Machine-written — may contain errors; check the original before relying on it.
