Iran war threatens Trump’s affordability push as rising energy prices complicate Fed rate cuts

The war with Iran is quickly becoming an economic problem for the United States – and a political dilemma for the Federal Reserve.

Rising oil prices, shipping disruptions in the Middle East and new signs of weakness in the U.S. labor market create a complex backdrop, just as inflation began to show signs of improvement. For policymakers, the risk is a familiar but unwelcome scenario: rising prices coupled with slowing growth — a dynamic known as “stagflation” — that could make it harder for the Fed to cut interest rates and ease pressure on U.S. consumers.

Gas prices hit their highest level since September 2024 on Friday, according to AAA, with the national average reaching $3.32 per gallon. Meanwhile, U.S. crude oil posted its biggest weekly gain on record since 1983, a sign that gas prices could continue to rise in the days and weeks to come.

This comes as the Federal Reserve is already grappling with signs of a weakening labor market. New data from the Bureau of Labor Statistics released Friday show the U.S. economy lost 92,000 jobs last month, while revisions for December and January found 69,000 fewer jobs than initially expected.

Impacts of shipping disruptions

Typically, signs of a slowing labor market would prompt the Federal Reserve to consider cutting interest rates to achieve maximum, sustainable employment — half of the central bank’s dual mandate, which also includes keeping prices stable and keeping inflation near its 2% target.

But the war in Iran complicates this calculation. Rising oil prices and shipping disruptions threaten to drive up energy costs across the global economy, potentially fueling inflation, which is already above the Fed’s target of 2.4%.

This dynamic requires policymakers to balance competing risks.

“The February report and the latest geopolitical developments complicate the Fed’s job by increasing risks on both sides of the dual mandate,” Gregory Daco, chief economist at EY, wrote in a client note Friday. “The sharp decline in the wage bill, rising unemployment rates and weak labor supply are heightening concerns about the negative impact on growth and employment, while the conflict in the Middle East increases the risk of inflation. »

Much of that risk centers on the Strait of Hormuz, a narrow waterway along Iran’s southern coast that carries about a fifth of the world’s oil supply. The passage is also a key shipping route for products such as aluminum, sugar and fertilizer.

With more than 80% of global trade moving by sea, according to the World Bank, disruptions can ripple through global supply chains. Slower transportation can increase transportation costs, delay deliveries of raw materials and manufactured goods, and increase production expenses for businesses – pressures that often trickle down to consumers in the form of higher prices.

And the longer the disruptions in the Strait of Hormuz persist, the greater the potential impact on oil prices.

Goldman Sachs warned that “upside risks” for crude are “increasing rapidly,” noting that prices could climb above $100 a barrel if water transport flows remain significantly disrupted in the coming weeks.

Crude settled at just under $91 a barrel on Friday. Typically, each $1 increase in oil translates to about $0.02 to $0.03 per gallon at the pump, meaning sustained gains could continue to push gasoline prices higher.

“The rise in oil prices comes at a time when other indicators of near-term inflationary pressures are also starting to look a bit more concerning,” wrote Stephen Brown, deputy chief economist for North America at Capital Economics. “Even if oil prices fall sooner rather than later, it becomes increasingly difficult to envision Fed Chairman nominee Kevin Warsh persuading the rest of the Fed. [Fed] support further interest rate cuts until there is stronger evidence that inflation is on track to return to 2%.

All eyes on energy prices

Federal Reserve officials say they are closely monitoring both aspects of the economy. San Francisco Federal Reserve President Mary Daly told CNBC on Friday that February’s weak jobs data added to an already challenging policy environment, emphasizing that it was a “balancing risk calculation” for the future.

Other Fed officials say the Iran war’s impact on inflation may ultimately prove temporary. Federal Reserve Governor Christopher Waller told Bloomberg that policymakers are unlikely to overreact to rising gas prices in the near 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 rising costs for essentials like groceries and housing, as well as rising prices in categories of goods like clothing and furniture, where tariffs have already driven up costs. But this cushion disappears quickly.

Earlier this week, Trump attempted to stabilize oil markets by announcing plans for maritime risk insurance and naval escorts through the Strait of Hormuz. So far, these efforts have done little to dampen market volatility or rising prices.

“It doesn’t concern me,” Trump told Reuters in an interview on Thursday. “[Gas prices] will go down very quickly once this period is over, and if they go up, they will go up, but that’s a lot more important than seeing gas prices go up a bit. »

But for policymakers in Washington, the economic stakes go far beyond just gasoline.

If inflation starts to rise again, the Federal Reserve could be forced to keep interest rates higher for longer — which would prolong the high borrowing costs that consumers have already made clear they want to eliminate — and could potentially undermine the president’s economic message just months before the November midterm elections.

What if the economy deteriorates and the job market weakens significantly at the same time? Expect a bumpy and very uncertain road ahead.

“The Fed’s reaction function is going to get a real stress test,” said Joe Bruselas, chief economist at RSM. “The risk of stagflation persists…and all eyes will continue to be on the direction of energy prices. »