A prolonged conflict between Israel and Iran may do more than rattle energy markets. One argument on Wall Street is that it could push the Federal Reserve to cut interest rates sooner than expected.
“A sustained rise in oil prices could cause the Fed to strike a more dovish tone,” Oxford Economics chief US economist Ryan Sweet wrote in a recent note to clients, arguing that an extended oil shock could dent demand and potentially spill over into an otherwise resilient labor market.
That’s because, historically, sudden spikes in oil prices tend to cause only a temporary rise in inflation that the Fed usually overlooks. But with the economy already softening, a persistent surge could pose a bigger threat to growth and jobs than to inflation itself.
“The economy has slowed and is vulnerable to anything else going wrong, including a sudden and persistent increase in oil prices,” Sweet said. “If the Fed views the hit to the economy and the labor market as greater than the temporary boost to inflation, the central bank could signal that it’s open to cutting interest rates sooner.”
On Tuesday, oil prices rallied, with international benchmark Brent (BZ=F) rising above $75 a barrel after President Trump called for Tehran residents to evacuate and rebuffed the idea of an Israel-Iran ceasefire.
That contrasted with optimism on Monday, when the Wall Street Journal reported that tensions between Iran and Israel had eased, sparking a rally in US equities and stabilizing crude oil prices following last week’s biggest price surge in three years.
Sweet, whose baseline forecast is that the Fed will deliver its first rate cut in December, noted it may take weeks before markets gain a clearer sense of the direction of oil prices.
