By Lina Irawan 
The escalating conflict in the Middle East has indeed sent global oil prices spiraling, with benchmark crudes like Brent Crude soaring to more than $100 a barrel over the weekend – a psychological and economic threshold not seen consistently since 2014, with brief spikes during the initial phases of the Russia-Ukraine war. This sharp increase immediately triggered widespread concern, particularly among consumers in the Western world, who were observed panic-buying supplies, reminiscent of the early days of the COVID-19 pandemic or previous energy crises. Such behavior, fueled by fear of future scarcity and price hikes, not only exacerbates immediate demand but also signals a worrying shift in inflation expectations among households and businesses.
Oil and energy prices are foundational components of modern economies, influencing everything from transportation costs and manufacturing expenses to food production and residential utility bills. A sudden and sustained surge in this critical commodity directly translates into higher input costs for businesses, which are then passed on to consumers in the form of elevated prices across a broad spectrum of goods and services. This direct pass-through immediately inflates headline Consumer Price Index (CPI) readings. While economists often strip out volatile food and energy prices to calculate "core inflation" for a clearer picture of underlying price trends, the reality is that sustained energy price shocks inevitably permeate core categories over time through these second-round effects, making them a crucial factor in the inflationary outlook.
This situation presents a formidable challenge for central banks worldwide, many of which are explicitly mandated to maintain price stability as a primary objective. For instance, in the United States, the Federal Reserve operates under a dual mandate: achieving maximum employment and maintaining price stability, with a long-term inflation target of 2%. The current inflationary environment already presents a sticky problem for the Fed. The latest CPI reading from the Bureau of Labor Statistics (BLS) indicated inflation at 2.4% over the past 12 months, marginally above the Fed’s target, but with some crucial categories, such as food and energy services, showing price increases well above that level. This persistent stickiness, even before the latest oil shock, suggested that the Fed’s job of bringing inflation back to target was proving more difficult than initially anticipated. Other major central banks, including the European Central Bank (ECB) and the Bank of England (BoE), face similar dilemmas, grappling with elevated inflation rates that often reflect a combination of supply-side constraints and robust demand.
The immediate upward pressure on energy costs, impacting the finances of households and businesses alike, will inevitably work against any calls for a lower base rate – a consistent argument put forth by President Trump and his cabinet for the past year. Trump has long advocated for lower interest rates, believing they stimulate economic growth and could provide a boost ahead of upcoming elections. However, central banks, valuing their independence from political interference, are unlikely to yield to such pressure when faced with a clear inflationary threat.
Indeed, President Trump is likely to be disappointed. Thierry Wizman and Gareth Berry, astute strategists at Macquarie, contend that even if the immediate hostilities in Iran were to quickly de-escalate or draw to a close, it would still take months before central banks could confidently assess that the inflationary impacts have fully subsided. Their analysis underscores the lag effects inherent in economic data and monetary policy. "Pres. Trump’s suggestion that the war will resolve ‘very soon’ may have been merely a reflection of Iran’s degraded capacity to fight back, rather than a tactical retreat by the U.S.," the duo observed in a recent note to clients. "If so, we can still expect hostilities will wind down, but around month-end, and not now." This extended timeline, even if brief in geopolitical terms, is significant in economic cycles. "That’s still enough time to cause psychic damage to investors, consumers, and adversely affect economic data for the April release cycle in May," they concluded, highlighting the profound psychological impact of uncertainty on economic behavior, which can translate into reduced investment, dampened consumer spending, and ultimately, slower growth.
The critical question of how these higher oil prices will pass through to consumers and the broader economy will undoubtedly loom large at the Federal Open Market Committee’s (FOMC) upcoming rate-setting meeting next week. The structural factors contributing to the rise in oil prices are also not easily rectified, underscoring the deep-seated nature of the problem. Iran borders the Strait of Hormuz, a notoriously narrow and strategically vital waterway in the Persian Gulf. This chokepoint is through which a substantial portion – estimated at 20-25% of the world’s total petroleum liquid consumption – from major oil-exporting nations like the UAE, Qatar, Kuwait, and Iraq, all flow. The heightened tensions have rendered shipmasters extremely nervous about navigating this crucial maritime route, leading to increased shipping costs and significant delays.
In an effort to keep this indispensable trade artery open and mitigate supply risks, the White House has reportedly explored various measures, including offering military escorts to commercial vessels traversing the Strait, alongside attempts to secure enhanced insurance guarantees for shipmasters. However, the administration’s communication on these efforts has been inconsistent, further fueling market uncertainty. Energy Secretary Chris Wright’s social media post yesterday claiming a U.S. Navy vessel had already escorted an oil tanker through the Strait was later deleted, with White House Press Secretary Karoline Leavitt subsequently confirming that the military had not, in fact, provided such an escort. This episode of miscommunication or retraction only serves to undermine confidence in the stability of the region and the efficacy of mitigation strategies.
Macquarie strategists further stressed the universal central bank response: "Almost all [central banks] will tilt to the hawkish side of the rhetorical spectrum while oil prices stay high." This means a collective inclination towards prioritizing inflation control, potentially through higher interest rates or a tighter monetary stance, even at the risk of curbing economic growth. They elaborated, "We would expect that this more ‘hawkish’ disposition persists even after hostilities end, largely because the data may continue to point to inflationary pressures (and hence a shift in public expectations) throughout the period in which inflation may show up in the data – i.e., through the May reporting cycle." The concern here is not just about current data, but about the entrenchment of inflation expectations. If consumers and businesses begin to expect higher inflation consistently, they will demand higher wages and raise prices, creating a self-fulfilling prophecy that is much harder for central banks to combat.
Inflation, however, is only one half of the Fed’s critical dual mandate. The other half is maintaining stable employment and achieving maximum sustainable employment. While investors appear relatively convinced that the Fed will prioritize inflation control in the face of rising oil prices, pricing out any immediate rate cuts, Bank of America’s Aditya Bhave offers a nuanced, potentially contrarian perspective. According to CME’s FedWatch barometer, speculators are currently pricing in more than a 99% chance of a hold at the upcoming FOMC meeting, reflecting a strong consensus that rate cuts are off the table for now.
However, in a note released yesterday, BofA’s senior economist Aditya Bhave suggests that markets might be misreading the Fed’s likely response to a persistent oil price shock. He posits that supply shocks, unlike demand-driven inflation, create risks to both sides of the Fed’s dual mandate. While they push up prices, they also tend to dampen economic activity and employment as higher input costs squeeze corporate margins and reduce consumer purchasing power. This dilemma is compounded by what Bhave describes as a sluggish employment outlook. The most recent jobs report from the BLS showed nonfarm payroll employment edged down by a significant 92,000 in February, and the unemployment rate rose to 4.4%. While 4.4% is still historically low, the downward trend in payrolls and the upward tick in unemployment signal a softening labor market that could deteriorate further under the strain of an oil shock. Other indicators, such as a slowdown in wage growth and a slight dip in labor force participation, further support this view of a cooling job market.
Bhave draws a crucial distinction by comparing the current situation to the supply shock experienced when Russia invaded Ukraine in 2022. At that time, the U.S. economy was characterized by exceptionally strong demand: the unemployment rate was below 4%, core Personal Consumption Expenditures (PCE) inflation (the Fed’s preferred gauge) was over 5%, nonfarm payrolls were robustly running at 500,000 per month, and consumers were still flush with COVID-19 stimulus cash. In that environment, the Fed could, and did, squarely focus on taming inflation through aggressive rate hikes, as the economy was strong enough to withstand significant tightening.
"By contrast," Bhave explains, "we now have a soft labor market, moderately elevated inflation and more modest fiscal support. This sets us up for a more dovish Fed response if the oil shock is persistent." This is a pivotal point. With a labor market already showing signs of weakness, inflation hovering above target but not spiraling out of control as it was in 2022, and less government stimulus to cushion the blow, a persistent oil shock could force the Fed to weigh the risks of further employment deterioration more heavily against the imperative to control inflation. A "more dovish Fed response" in this context could mean a reluctance to hike rates further, or even a reconsideration of rate cuts sooner than markets currently expect, particularly if the employment picture darkens considerably.
The convergence of geopolitical instability, its immediate and protracted impact on energy prices, and the delicate balance within central bank mandates creates an exceptionally complex and uncertain outlook for global markets and economies. The tension between political assurances and economic realities, coupled with the potential for a dual hit to both inflation and employment, ensures that central bankers face one of their most challenging periods yet, with far-reaching implications for businesses, consumers, and the trajectory of the global recovery.