An overnight jump in oil prices on the heels of a hawkish Federal Reserve policy meeting has further narrowed the window for the interest rate cuts President Donald Trump has demanded and upped the odds that his nominee to lead the U.S. central bank may need to tighten borrowing costs early in his tenure. A recent escalation in the U.S.-Israeli war with Iran, with oil and gas facilities being directly targeted, drove benchmark crude prices above $118 a barrel before they fell back on Thursday morning. The average cost of U.S. gasoline rose to $3.88 a gallon, marking a roughly 30% jump from before the start of the joint U.S.-Israeli bombing campaign. The sudden shift in the geopolitical outlook has pushed major central banks into a cautious stance, and Fed policymakers on Wednesday were no exception as they penciled in higher inflation for the year than previously anticipated.
While U.S. central bank policymakers’ latest projections still anticipate a single quarter-percentage-point rate cut this year, Fed Chair Jerome Powell cautioned that any projection at this point should be taken with a “grain of salt” given the uncertainty about how long the war will last, how high oil prices might go, and what the global fallout will be in terms of inflation and any blow to growth as consumers shift their spending patterns or scale back on purchases. Investors see inflation risks as paramount and the U.S. central bank likely sidelined from any interest rate changes, a blow to Fed chief nominee Kevin Warsh’s outlook, announced in press interviews and news articles before he was chosen to replace Powell, that the central bank could cut rates and count on rising productivity to safely lower inflation. As of Thursday morning, investors were putting roughly equal odds of about 10% on a Fed rate hike versus a rate cut by the end of this year, though that positioning was shifting as oil prices eased and the leaders of Britain, France, Germany, Italy, the Netherlands and Japan issued a joint statement urging “an immediate comprehensive moratorium on attacks on civilian infrastructure, including oil and gas installations,” and said they were prepared “to contribute to appropriate efforts to ensure safe passage” of oil and other goods through the strategic Strait of Hormuz off Iran’s southern coast.
Shipping through the narrow channel has been thwarted by Iranian counterattacks and threats, a fresh supply shock to a global economy that has had to weather several such blows since the outbreak of a worldwide pandemic in 2020. This week the damage moved more to the heart of the oil and gas industry, with an Israeli strike against a major Iranian gas field, and Iranian retaliation against a major natural gas plant in Qatar that could impair an important global supplier for years.
The strikes highlighted what Powell emphasized in a press conference following the Fed’s decision to hold U.S. interest rates steady for now: that policymakers have no way to predict what will happen next and will have to feel their way as events unfold.
Higher prices are sure to follow the jump in oil, Powell said, but whether that’s a problem or not depends on how high and for how long prices are elevated and how deeply rising energy costs seep out into the economy. Diesel fuel, key to the trucking industry, topped $5 a gallon this week, and airlines are warning of higher ticket prices to offset the cost of more expensive jet fuel.
Consumers and businesses, however, will respond, with shifts in demand and consumption that could mute inflation but put the Fed’s other goal of maximum employment further at risk.
“Nobody knows. The economic effects could be bigger. They could be smaller,” than expected, Powell said. “We don’t debate how long,” the war will last, he added. “How do you do that? We wouldn’t be able to debate what the length or size of the effects will be.”
The projections issued this time were “something that people wrote down,” Powell said, comparing the current level of uncertainty to the early days of the COVID-19 pandemic when the Fed skipped one set of quarterly projections given the depth of the economic changes unfolding in real time.
(Reporting by Howard Schneider; Editing by Paul Simao and Andrea Ricci )