The US economy needs the fragile ceasefire President Donald Trump brokered in the Middle East to hold.
If thepause in fightingbetween Israel and Iran fails and major hostilities resume, oil prices would likely spike again. And surging gasoline prices are the last thing the US economy needs right now.
Inflation is alreadyexpected to heat up this summerbecause of Trump’s massive tariffs on imports. An oil shock would make matters worse — perhaps much worse.
“It would be a bit of a double-whammy. First there’s the stagflationary shock from tariffs. And then a potential oil shock,” Alan Blinder, economics professor at Princeton University and a former top Federal Reserve official, told CNN in a phone interview.
In many ways, Trump’s trade war gives him less margin for error in the Middle East. He can’t afford another world event that causes inflation to rear its ugly head again andfurther delays rate cuts from the Fed.
“The economy is vulnerable to anything that could go wrong, and this certainly qualifies,” said Mark Zandi, chief economist at Moody’s Analytics.
That’s why investors arebreathing a huge sigh of reliefin recent days. Stocks have popped andoil prices have plungedin one of the biggest sell-offs in years.
Iran’s response to US strikes on nuclear sites was far more limited, and symbolic, than feared. Not only that, but the ceasefire between Israel and Iran eases fears that vital energy infrastructure in the region will get caught in the crossfire.
Thenightmare scenariohad been that Iran would try to close the Strait of Hormuz, the most critical oil chokepoint on the planet.
Analysts have warned that if this waterway shut down, oil prices could easily spike beyond $100 or $120 a barrel, causing a return of $4 to $4.50 gas in the US.
As of Sunday, the odds of Iran closing the Strait of Hormuz spiked to about 60% on prediction platformPolymarket.
But by Tuesday, the odds plunged to just 17% as investors bet the worst in the Israel-Iran crisis may be over.
Observers have noted that closing the Strait of Hormuz would be counterproductive for Iran, which relies on the waterway to get its own oil to customers, mostly in China.
“They would be shooting themselves in the foot,” Blinder said, “but countries have been known to do that.”
Critics of Trump’s aggressive use of tariffs warn that they will backfire, too.
However, inflation has cooled in recent months even as Trump has lobbed tariffs on autos, steel, aluminum and imports from most countries.
Yet many economists say this is the calm before the storm, with tariff-fueled price hikes on the way. Some items exposed to tariffs like appliances, toys and electronics have already become more expensive.
“In many ways, the past few months may be transitory low inflation before the price effect of tariffs hit,” Bob Elliott, CEO of alternative investment firm Unlimited, told CNN in a phone interview. “No serious economist would look at inflationary trends and forecast they will exist into the future.”
Unless tariffs get dramatically scaled back, Elliott said inflation is likely to heat up by 1% to 1.5% from current levels.
“That’s not going to be acceptable for the Fed,” said Elliott.
In testimony before Congress Tuesday, Fed Chair Jerome Powell reiterated the central bank’s wait-and-see stance, telling lawmakers: “I wouldn’t want to point to a particular meeting. I don’t think we need to be in any rush because the economy is still strong.”
If the situation in the Middle East does turn south again, it would create a potential boost to energy prices.
“It would be a tricky combination,” said Elliott, a former executive at hedge fund giant Bridgewater Associates.
Oil shocks can be very inflationary because energy prices feed in to many parts of the US economy.
Not only that, but there can be a psychological effect given how closely Americans follow gas prices.
And it’s only been three years since gas prices spiked above $5 a gallon for the first time ever after Russia’s invasion of Ukraine. Inflation skyrocketed to four-decade highs and the Fed was forced to put the fire out by dramatically lifting borrowing costs.
“People look at prices at the pump as a litmus test for inflation broadly,” said Zandi, the Moody’s economist.
For now, gas prices appear to have stabilized. The national average price of regular gas wasflat at $3.22 a gallonon Tuesday, according to AAA. That’s up from $3.13 a gallon when Israel attacked Iran earlier this month. However, it’s still lower than $3.45 a gallon a year ago.
In a speech on Tuesday, Cleveland Fed President Beth Hammack noted oil prices “bear watching” given the recent price swings from geopolitical events.
“The pain of large increases in energy prices still weighs on consumer spending,” Hammack said, while noting that the US is less exposed to oil shocks than in the past. “Recent increases in oil prices pose an upside risk to the stability of inflation expectations.”
The scars of $5 gasoline in 2022 loom large.
For now, investors are hoping the ceasefire in the Middle East means there won’t be a repeat today.