Inflation threat may reignite? US-Iran conflict further reduces the likelihood of the Federal Reserve cutting interest rates!

Caixin March 2 News (Editor: Xiaoxiang) Over the weekend, attacks by the U.S. and Israel on Iran are undoubtedly causing turbulence in the oil markets. Many Wall Street analysts suggest that these attacks could also reduce the likelihood of the Federal Reserve cutting interest rates this year.

Data shows that after the U.S. and Israel attacked Iran, international oil prices surged on Monday morning, with Brent crude futures jumping 13% to $82 per barrel at the open, and WTI crude futures rising over 10% to $75 per barrel. Clearly, as trading resumed intra-day, with investors assessing global energy supply risks—especially the risks through the Strait of Hormuz (which carries about one-fifth of the world’s oil and liquefied natural gas)—oil prices experienced a stress-induced rally.

Joe Brusuelas, Chief Economist at RSM, pointed out that as Asian markets opened first, oil prices opened high, and investors initially favored dollar assets for safe-haven during the early stages of the conflict. If crude prices remain high, retail gasoline prices are likely to follow suit.

Patrick De Haan, Head of Petroleum Analysis at GasBuddy, said that the current national average gasoline price is about $3 per gallon. If crude costs continue to rise, this average could climb to $3.10–$3.15 in the coming weeks. For the Federal Reserve, this upward trend hits a particularly sensitive window.

Currently, U.S. inflation has been deviating from the Fed’s 2% target for nearly five years, and with tariffs beginning to pass through to consumers, price pressures are mounting. Service sector inflation, in particular, shows strong stickiness. As anti-inflation efforts stall, markets are steadily lowering expectations for rate cuts in 2026.

Analysts note that although energy prices are not included in the Fed’s preferred core PCE inflation index, policymakers often argue that monetary policy should not overreact to short-term volatile energy prices. However, this strategy is more convincing when inflation is moderate and expectations are stable.

At present, market expectations are unusually fragile. Gasoline prices, as the most perceptible household expense, influence the overall outlook. After years of high inflation, the renewed rise in gas station prices can reinforce public perception that “inflationary pressures are deeply rooted.” Once inflation hovers around 3%, dovish arguments for easing policy will become increasingly weak.

This situation will also strengthen the voice of “hawkish” Fed officials, who have previously warned against premature rate cuts.

Most Fed policymakers have stated that they need more concrete evidence of inflation returning to target before shifting policy. The ongoing rise in oil prices provides them with more reason to maintain high interest rates and stay on the sidelines.

William Jackson, Chief Emerging Markets Economist at Capital Economics, noted in a Saturday report that, based on empirical rules, a 5% annual increase in oil prices typically raises inflation in major economies by about 0.1 percentage points. This means that if Brent crude rises to $100 per barrel, global inflation could increase by 0.6–0.7 percentage points.

“This could slow the pace of monetary easing by major central banks, especially in emerging markets, where policymakers tend to be more sensitive to fluctuations in commodity prices,” he added.

According to the CME FedWatch tool, investors further adjusted their rate expectations on Monday, reducing bets on a rate cut by the Fed in June. Currently, the probability of holding rates steady at the June meeting is 47%, up from 42.7% last Friday.

Of course, some argue that high oil prices essentially act as a “tax,” squeezing household budgets and raising business costs, thereby restraining economic growth. This demand contraction, caused by reduced discretionary spending and squeezed profit margins, could cool demand-driven inflation to some extent.

This coexistence of “upward inflation pressures” and “downward growth risks” will undoubtedly complicate the Fed’s decision-making. Overreacting to energy costs could lead to excessive tightening, while ignoring them risks losing control of inflation expectations.

Many interest rate traders are already focusing on the earlier Fed rate decision this month—although the March policy statement may not directly mention Iran, it is very likely to emphasize increased geopolitical uncertainties and the potential risks from energy price volatility.

Fortunately, today’s situation differs from the epic oil price surge triggered by Russia-Ukraine conflict in 2022. Back then, global demand was rebounding rapidly from pandemic lows, and capacity was severely constrained; Iran’s energy exports are also much smaller than Russia’s, and the current global supply-demand balance is relatively more resilient. Nonetheless, under the dual pressures of tariffs and service sector inflation, this supply-side shock significantly raises the likelihood of maintaining higher interest rates for a longer period.