Iran war threatens Trump’s reach as rising energy prices complicate Fed rate cut
War with Iran is fast becoming an economic problem for the United States – and a policy problem for the Federal Reserve.
Rising oil prices, shipping disruptions in the Middle East and new signs of weakness in the US labor market create a complex backdrop just as inflation has begun to show signs of improvement. For policymakers, the risk is a familiar but unacceptable scenario: high rates coupled with slow growth – a phenomenon known as “stagflation” – could make it difficult for the Fed to cut interest rates and ease pressure on American consumers.
Gasoline prices on Friday hit their highest level since September 2024, according to AAA, with the national average reaching $3.32 per gallon. Meanwhile, US crude posted its biggest weekly gain in data records dating back to 1983, a sign that fuel prices could continue to rise in the coming days and weeks.
This comes as the Federal Reserve is already dealing with signs of a weakening labor market. New data from the Bureau of Labor Statistics released Friday showed the US economy lost 92,000 jobs last month, while revisions to December and January revealed 69,000 fewer jobs than originally estimated.
Effects of shipping disruptions
In general, signs of a softening labor market could push the Federal Reserve to consider lowering interest rates in order to secure higher, more sustainable employment – one part of the central bank’s dual mandate, which includes keeping prices stable and keeping inflation close to its 2% target.
But the war in Iran complicates that calculation. Rising oil prices and shipping disruptions threaten to raise energy costs in the global economy, potentially fueling inflation, which is already running above the Fed’s target of 2.4%.
That flexibility leaves policymakers balancing competing risks.
“The February report and recent political developments complicate the Fed’s job by increasing risks on both sides of the dual mandate,” wrote Gregory Daco, chief economist at EY, in a client note on Friday. “A sharp decline in wages, a rise in the unemployment rate and a weak labor market are raising concerns about growth and employment, while the conflict in the Middle East raises the risk of inflation.”
Most of those risk areas are located in the Strait of Hormuz, a narrow waterway along Iran’s southern coast that carries about one-fifth of the world’s oil. The corridor is also an important transport route for goods including aluminium, sugar and fertiliser.
With more than 80% of the world’s trade moving by sea, according to the World Bank, disruptions can occur within supply chains around the world. Slow shipping can increase freight costs, delay the delivery of raw materials and manufactured goods, and increase production costs for companies – pressures that often filter through to consumers in the form of higher prices.
And the longer disruptions in the Strait of Hormuz continue, the greater the potential impact on oil prices.
Goldman Sachs warned that the “existing risks” of pollution are “rising rapidly,” noting that prices could rise above $100 per barrel if the ship’s flow through the waterway remains severely disrupted in the coming weeks.
Crude settled just below $91 a barrel on Friday. Typically, every $1 increase in oil translates to about $0.02 to $0.03 per liter at the pump, meaning continued gains can continue to drive up fuel prices.
“The rise in oil prices comes at a time when other indicators of near-term inflationary pressures are also becoming more apparent,” wrote Stephen Brown, deputy chief economist for North America at Capital Economics. “Even if oil prices recover quickly, it’s hard to imagine Fed Chairman-elect Kevin Warsh persuading everyone else. [Fed] support further interest rate cuts until there is strong evidence that inflation is on the way back to 2%.
All eyes on energy prices
Federal Reserve officials say they are looking closely at both sides of the economy. San Francisco Federal Reserve President Mary Daly told CNBC on Friday that February’s weak jobs data added to an already difficult policy-making environment, noting that the “calculations of danger” going forward.
Some Fed officials believe the impact of the Iran war on inflation may be temporary. Federal Reserve Governor Christopher Waller told Bloomberg that policymakers are unlikely to overreact to higher gas prices in the short term.
But gas prices are one of the few areas where American consumers have seen some relief — and a key talking point in President Donald Trump’s affordability agenda.
Lower gas prices in recent months have helped offset the rising cost of essentials such as groceries and housing, as well as higher prices in goods categories such as clothing and furniture, where prices have already increased costs. However, that cushion is quickly disappearing.
Earlier this week, Trump tried to stabilize oil markets by announcing plans for marine accident insurance and escorting warships through the Strait of Hormuz. So far, those efforts have done little to dampen market volatility or rising prices.
“I don’t have a problem with it,” Trump told Reuters in an interview on Thursday. “[Gas prices] they will go down very quickly once this is over, and if they go up, they go up, but this is more important than the increase in fuel prices.”
But for policymakers in Washington, the economic figures go beyond just fuel.
If inflation starts to rise again, the Federal Reserve could be forced to keep interest rates higher for longer — extending the expensive borrowing costs consumers have already made clear they want to pass — and potentially undermine the president’s economic message in the months before November’s midterm elections.
And if the economy crashes and the labor market weakens at the same time? Expect a bumpy and very uncertain road ahead.
“The Fed’s reactionary work will face a real stress test,” said Joe Bruselas, chief economist at RSM. “The risk of stagflation is rife … and all eyes will continue to be focused on the direction of energy prices.”
