Iran conflict jeopardizes Trump's efforts to lower costs as increasing energy prices make Fed rate reductions more challenging

Economic Fallout from the Iran Conflict: Challenges for the U.S. and the Federal Reserve

A tanker navigates the Strait of Hormuz in Ras Al Khaimah on February 25. Photo by Fadel Senna.

The ongoing conflict involving Iran is swiftly turning into a significant economic challenge for the United States, presenting a complex scenario for the Federal Reserve to navigate.

Escalating oil prices, shipping slowdowns in the Middle East, and new indications of weakness in the U.S. job market are all converging just as inflation had started to show improvement. Policymakers now face the unwelcome prospect of rising prices combined with slowing economic growth—a situation known as stagflation—which could complicate efforts by the Fed to lower interest rates and provide relief to consumers.

According to AAA, gasoline prices on Friday reached their highest point since September 2024, with the national average at $3.32 per gallon. At the same time, U.S. crude oil saw its largest weekly increase on record since 1983, suggesting that fuel costs may continue to climb in the near future.

This surge comes as the Federal Reserve is already contending with signs of a cooling labor market. Fresh data from the Bureau of Labor Statistics revealed a loss of 92,000 jobs in the past month, with previous months’ figures revised downward by 69,000 positions.

Shipping Disruptions and Their Consequences

Ordinarily, evidence of a weakening job market would prompt the Federal Reserve to consider lowering interest rates to support employment—a key part of its dual mandate, which also includes keeping inflation near 2%.

However, the conflict in Iran is complicating this approach. The combination of rising oil prices and shipping bottlenecks threatens to drive up energy costs worldwide, potentially accelerating inflation, which is already above the Fed’s 2.4% target.

This situation forces policymakers to weigh competing risks.

Gregory Daco, chief economist at EY, noted, “The latest jobs report and geopolitical tensions are making the Fed’s task more difficult by increasing risks on both sides of its mandate. The sharp drop in payrolls, higher unemployment, and weaker labor supply raise concerns about slower growth, while the Middle East conflict adds to inflationary pressures.”

A significant portion of this risk is tied to the Strait of Hormuz, a narrow passage along Iran’s southern border that handles about 20% of the world’s oil shipments. It’s also a vital route for other goods like aluminum, sugar, and fertilizer.

With over 80% of global trade transported by sea, according to the World Bank, disruptions in this region can send shockwaves through global supply chains. Slower shipping increases freight costs, delays the delivery of raw materials and finished products, and raises production expenses for businesses—costs that are often passed on to consumers through higher prices.

Prolonged Disruptions and Oil Price Risks

The longer shipping issues persist in the Strait of Hormuz, the greater the risk of further oil price spikes.

Goldman Sachs has cautioned that the “upside risks” for crude oil are “growing rapidly,” suggesting that prices could surpass $100 per barrel if shipping remains heavily affected in the coming weeks.

On Friday, crude oil closed just below $91 a barrel. Typically, each $1 increase in oil prices adds about 2 to 3 cents per gallon at the pump, so continued gains could keep pushing gasoline prices upward.

Stephen Brown, deputy chief North America economist at Capital Economics, remarked, “The recent jump in oil prices coincides with other signs of rising inflationary pressures. Even if oil prices retreat soon, it’s becoming harder to see the Fed supporting further rate cuts without stronger evidence that inflation is returning to 2%.”

Energy Prices in the Spotlight

Federal Reserve officials are closely monitoring both inflation and employment. San Francisco Fed President Mary Daly told CNBC that February’s weak jobs report has made policy decisions even more challenging, describing the situation as a “balance of risks calculation.”

Some Fed members believe the inflationary impact of the Iran conflict may be short-lived. Fed Governor Christopher Waller told Bloomberg that policymakers are unlikely to react strongly to higher gas prices in the immediate term.

However, gasoline prices have been one of the few areas where Americans have recently experienced some relief, and they remain a central issue in President Donald Trump’s affordability agenda.

Lower fuel costs in recent months have helped offset rising expenses for essentials like food and housing, as well as higher prices for goods such as clothing and furniture, where tariffs have already driven up costs. That buffer, however, is quickly eroding.

Earlier this week, President Trump announced plans for maritime risk insurance and naval escorts through the Strait of Hormuz in an effort to calm oil markets. So far, these measures have not significantly reduced market volatility or curbed rising prices.

“I’m not worried about it,” Trump told Reuters on Thursday. “Gas prices will fall quickly once this is over. If they go up, so be it—this is more important than a temporary increase at the pump.”

Yet for policymakers in Washington, the economic implications go far beyond just gasoline costs.

If inflation accelerates again, the Federal Reserve may be forced to keep interest rates elevated for a longer period—prolonging high borrowing costs that many Americans are eager to see end—and potentially undermining the president’s economic message ahead of the November midterm elections.

Should the economy worsen and the labor market weaken further at the same time, the outlook could become even more uncertain and volatile.

Joe Bruselas, chief economist at RSM, commented, “The Fed’s decision-making process is about to face a serious test. The threat of stagflation is real, and everyone will be watching where energy prices go from here.”

Adapted from an article originally published on NBCNews.com