Inflation held steady in February — but the latest reading offers some clarity to Federal Reserve officials as they navigate an increasingly complex economic landscape.
Consumer prices rose 2.4% from a year earlier, according to new government data released Wednesday, a figure that suggests inflation is gradually cooling toward the Fed’s 2% target.
But now, a sudden spike in oil prices linked to the war in Iran threatens to undo that progress and could put the central bank in a holding pattern when it comes to interest rates. The Fed’s policy-setting committee will make its next interest rate decision in a week.
“The February US consumer price index may be effectively ignored due to events in the Persian Gulf for policymakers and the public,” wrote Joe Brusulas, chief economist at RSM. He expected headline inflation to rise to 3% in March and 3.5% “or higher” in April as higher energy prices filter into the data.
“That doesn’t offer much comfort to the American central bank, which now focuses like a laser beam on short- and medium-term inflation expectations,” Brusulas wrote.
The national average price for inflation-adjusted gasoline hit $3.58 a gallon Wednesday, up $0.64 from last month, according to AAA. This is the highest level since May 2024. Meanwhile, US crude oil prices, a key component of gas, remained volatile after rising earlier in the week. Even after retreating from that high, prices are up roughly 30% from before the conflict began just two weeks ago.
The spike was caused by the effective closure of the Strait of Hormuz, a narrow waterway at Iran’s southwestern tip through which tankers carrying roughly a fifth of the world’s oil supply pass.
On Wednesday, the 32 countries that make up the International Energy Agency unanimously agreed to release 400 million barrels of oil from their reserves to boost supplies worldwide and prevent further price increases.
But inflation is not the only concern for Fed policymakers. The US labor market is also weakening.
New data from the Bureau of Labor Statistics released Friday showed the U.S. economy lost 92,000 jobs last month, but revisions for December and January revealed 69,000 fewer jobs than originally estimated.
“This labor market weakness comes with a movement toward more labor-reducing and cost-reducing productivity enhancements from many technological advances, but we have yet to see the real impact of AI-related alternatives on the labor market,” Rick Ryder, chief investment officer of global fixed income at BlackRock, wrote to clients on Wednesday.
“This puts the Fed in a challenging position, as the central bank will have to consider more policy accommodation if the labor market materially weakens further, but the timing of such moves is highly uncertain amid the oil price shock.”
Typically, signs of a softening labor market will push the Federal Reserve to consider cutting interest rates to achieve maximum, sustained employment — half of the central bank’s dual mandate, which is to maintain stable prices and keep inflation near its 2% target.
But the war in Iran is complicating that calculus, as inflation worries persist and leave policymakers to balance competing risks.
And that’s not all. Economists are also beginning to express concern over consumer spending, which is expected to receive a significant boost from new tax rules included in President Donald Trump’s “One Big Beautiful Bill.”
But so far, expectations have not matched reality.
Halfway through the tax season, Citi noted that individual federal refunds are tracking about $30 billion higher than last year, falling short of some estimates that had expected a $100 billion boost to U.S. households.
A smaller-than-expected fiscal tailwind could weigh on spending in the coming months and eventually drag down economic growth.
“Consumer spending is likely to slow this year, with less-than-consensus-expected fiscal stimulus and roughly zero net job growth,” Citi economists wrote.
For the Fed, the risk is a familiar but unwelcome scenario: Higher prices paired with slower growth — a dynamic known as “stagnation” — could make it harder for the central bank to cut interest rates and ease pressure on American consumers.
Adding another layer of uncertainty is changing tariff orientation.
Last month, the Supreme Court ruled many of President Donald Trump’s tariffs unconstitutional. Trump has replaced some of those tariffs with a global 10% tariff, but it’s unclear how the new tariffs will affect prices or whether refunds will be issued for tariffs already collected.
According to a Penn Wharton budget model, up to $175 billion in tariff refunds are at risk.
“Until the Strait of Hormuz opens and the turmoil in the Middle East subsides, the Federal Reserve may shy away from any action on interest rates,” wrote Skyler Wynand, chief investment officer at Dallas-based investment advisory firm Regan Capital.
“The Fed is now weakening jobs to sort out tariffs, potential tariff refunds, higher energy prices and any sort of clarity on what to do next,” he said.
Until then, wait for the fog to clear and then look at the mod again.
