Federal Reserve Chair Jerome Powell has cautioned that the U.S. economy is facing a new supply shock due to disruptions in Middle East oil supplies, following previous shocks from the COVID-19 pandemic and tariffs that pushed prices higher [1]. Speaking at Harvard University, Powell noted that these supply shocks have kept inflation elevated above the Fed's 2% long-run target, despite substantial progress in reducing inflation from its 9.1% peak in 2022 [1]. Powell stated, 'We got pretty close to 2% by the end of '24,' but highlighted that tariffs contributed between 0.5 and 0.8 percentage points to inflation, and now a fresh energy shock is emerging [1].
Oil prices have surged in response to the war in Iran, with West Texas Intermediate crude oil rising above $102 a barrel on Tuesday, compared to the $60-$70 range a month ago before the conflict began. Brent crude oil is trading around $112 a barrel and has approached $120 a barrel since the outbreak, after previously trading between $65 and $75 a barrel [1]. Gasoline prices have also spiked, with the national average price of regular gasoline increasing by over $1 per gallon in the last month—from $2.98 to $3.99 as of Monday, according to AAA data. This represents a 34% increase in the past month [1].
Powell emphasized the uncertainty surrounding the severity of the energy supply shock, stating, 'No one knows how big it will be, it's way too early to know.' He explained that the Federal Reserve's monetary policy is currently positioned to respond flexibly, allowing policymakers to either cut or hike interest rates as needed to support the economy or curb inflation [1]. Powell remarked, 'We do think our policy is in a good place for us to wait and see' [1].
Market expectations reflect this uncertainty, with an 80% probability that the Fed's benchmark federal funds rate will remain at its current range of 3.5% to 3.75% for the rest of the year [1].
CONCLUSION
The surge in oil and gasoline prices due to the Iran conflict has introduced a new supply shock, raising concerns about inflation and economic stability. Powell's remarks highlight the Fed's cautious stance and readiness to adjust policy as needed, while markets anticipate no immediate change in interest rates. The situation remains fluid, with the full impact of the energy shock yet to be determined.