As President Donald Trump declares inflation tamed, the Iran conflict threatens to unleash a new wave of price pressures, potentially derailing his case for lower interest rates. The sudden surge in oil prices, following a joint U.S.-Israel strike, has sent shockwaves through markets, with West Texas Intermediate futures rising over 5% and Brent crude futures gaining about 6%. This increase in oil prices adds to recent indicators that underlying price pressures remain, despite inflation being well off its highs of a few years ago. Historically, energy cost surges have often preceded broader inflation increases.
The global FX and rates strategist at Macquarie Group, Thierry Wizman, notes that "war has proven to be 'inflationary,' as it is associated with negative supply shocks." Even before the new U.S.-Iran war, oil prices were higher due to hoarding, and since hostilities began, prices are being pushed up by higher insurance premiums and forced re-routing of maritime shipping.
Outside of energy markets, there have been signs that inflation pressures may be firming. January's producer price index, a measure of wholesale costs and a proxy for pipeline inflation, rose a stronger-than-expected 0.8% excluding food and energy, pushing the 12-month rate to 3.6%, well above the Federal Reserve's 2% target. Additionally, the Institute for Supply Management reported that more than 70% of managers reported higher prices in February, an 11.5 percentage point jump from a month earlier.
However, most economists say the impact from higher oil prices is difficult to gauge and could ultimately prove temporary, as has often been the case with past Middle East conflicts. The duration of the war will be critical, with prolonged disruptions to shipping routes, higher insurance costs, and supply chain rerouting potentially amplifying inflationary pressures beyond the direct effect of higher gasoline prices.
With the U.S. producing a larger share of its own energy, the broader economic impact of oil price spikes is not what it once was. In today's American economy, spikes in oil prices do not present the same significant downside risk to top-line economic growth or inflation as they did a half-century ago. By one estimate, a $10 increase in oil prices would translate to roughly a 0.2 percentage point rise in inflation and a 0.1 percentage point drag on economic growth.
Crosscurrents remain, with the U.S. labor market showing signs of softening and the outlook for tariffs and fiscal policy remaining uncertain. Some economists warn of stagflation risks, where higher prices coincide with slower growth. Given that growth in most regions is still recovering from the pandemic, trade, and geopolitical tensions, stagflation risks may reemerge depending on how long Middle East tensions last.
Markets are betting that the central bank will remain on hold at its March meeting and potentially into the summer, as officials weigh the competing forces of higher energy prices and uneven growth. While this conflict heightens stagflationary risks for the global economy, it is unfolding against a backdrop of favorable growth-policy mix and resilient earnings. If the conflict ultimately leads to greater regional stability, it could even prove 'oil negative/growth positive in the medium term.'
In conclusion, the rise in oil prices will undoubtedly receive attention from the Fed, but movements in commodity prices, especially if short-lived, are typically 'looked through' by Fed officials, and may be modest in any case.
