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 are creating a difficult backdrop just as inflation had begun to show some signs of improvement. For policymakers, the risk is a familiar but unpleasant scenario: higher prices combined with slowing growth – a dynamic known as “stagflation” – that could make it difficult for the Federal Reserve to lower interest rates and ease pressure on American consumers.
Gasoline prices hit their highest level since September 2024 on Friday, according to AAA, with a national average of $3.32 per gallon. Meanwhile, U.S. crude oil posted its biggest weekly gain on record in data going back to 1983, a sign that gas prices could continue to rise in the coming days and weeks.
This comes as the Federal Reserve is already grappling with signs of a weakened labor market. New data from the Bureau of Labor Statistics released Friday showed the U.S. economy lost 92,000 jobs last month, while revisions to December and January revealed 69,000 fewer jobs than originally estimated.
Impacts of shipping disruptions
Normally, signs of a weakening labor market would lead the Federal Reserve to consider cutting interest rates to achieve maximum and sustained 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 is complicating that calculation. Rising oil prices and shipping disruptions threaten to raise energy costs across the global economy, potentially fueling inflation, which is already above the Federal Reserve’s target of 2.4%.
That dynamic leaves policymakers balancing competing risks.
“The February report and the latest geopolitical developments complicate the Fed’s job by raising risks on both sides of the dual mandate,” Gregory Daco, chief economist at EY, wrote in a client note on Friday. “The sharp decline in payrolls, the increase in the unemployment rate and the context of lower labor supply increase concerns about the decline in 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 commodities such as aluminum, sugar and fertilizers.
According to the World Bank, since more than 80% of global trade is carried out by sea, disruptions in that country can affect global supply chains. Slower shipping can increase freight costs, delay deliveries of raw materials and manufactured goods, and raise companies’ production expenses—pressures that often trickle down to consumers in the form of higher prices.
And the longer the disruptions in the Strait of Hormuz last, the greater the potential impact on oil prices.
Goldman Sachs warned that “upside risks” to crude oil are “growing rapidly,” noting that prices could rise above $100 a barrel if shipping flows through the waterway remain severely disrupted in the coming weeks.
Crude oil closed just under $91 a barrel on Friday. Typically, every $1 increase in oil translates to about $0.02 to $0.03 per gallon at the pump, meaning sustained gains could continue to push gas prices higher.
“The jump in oil prices comes at a time when other indicators of near-term inflation pressures are also starting to look a little more worrying,” wrote Stephen Brown, deputy chief North American economist at Capital Economics. “Even if oil prices fall sooner rather than later, it is increasingly difficult to imagine that Federal Reserve Chairman nominee Kevin Warsh will convince the rest of the (Fed) to support further interest rate cuts until there is firmer evidence that inflation is on track to return to 2%.”
All eyes on energy prices
Federal Reserve officials say they are closely watching both sides of the economy. San Francisco Federal Reserve President Mary Daly told CNBC on Friday that February’s weak jobs data added to an already difficult policymaking environment, noting that it is “a risk-balancing calculation” going forward.
Other Federal Reserve officials believe the impact of the Iran war on inflation may ultimately prove temporary. Federal Reserve Governor Christopher Waller told Bloomberg that authorities 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 on President Donald Trump’s affordability agenda.
Lower gas prices in recent months have helped offset rising costs for staples like food and housing, as well as higher prices in categories of goods like clothing and furniture, where tariffs have already driven up costs. However, that cushion is disappearing quickly.
Earlier this week, Trump attempted to stabilize oil markets by announcing plans for marine risk insurance and naval escorts through the Strait of Hormuz. So far, those efforts have done little to alleviate market volatility or rising prices.
“I don’t have any concerns about it,” Trump told Reuters in an interview on Thursday. “(Gas prices) will go down very quickly when this is over, and if they go up, they will go up, but this is much more important than gas prices going up a little bit.”
But for policymakers in Washington, the economic stakes go far beyond gasoline.
If inflation begins to rise again, the Federal Reserve could be forced to keep interest rates high longer — prolonging costly borrowing costs that consumers have already made clear they want to eliminate — and potentially undermining the president’s economic message just months before the November midterm elections.
What if the economy deteriorates and the labor market weakens materially at the same time? Expect a bumpy and very uncertain road ahead.
“The Fed’s reaction function is going to experience a real stress test,” said Joe Brussels, chief economist at RSM. “The risk of stagflation is present… and all eyes will remain focused on the direction of energy prices.”
