The tense situation in Iran pushing up oil prices, the Fed's room for interest rate cuts within this year is "disappearing".

Rising oil prices and the added pressure of tariffs are rapidly narrowing the space for the Federal Reserve's monetary policy. Several economists have warned that if the United States takes military action against Iran, the inflation situation will further deteriorate, and the possibility of the Fed cutting interest rates this year may be completely dashed. With the escalating tensions between the US and Iran, WTI crude oil futures have risen by about 16% since the beginning of the year, with prices per barrel rising by about $10 compared to the beginning of the year. Brian Bethune, an economist at Boston College, said in a media interview, "The reasons to support a rate cut are disappearing right before our eyes." He pointed out that rising oil prices combined with the Trump administration's aggressive tariff policies are adding upward pressure on inflation, making the decision to cut rates more complex. Derivatives market traders currently expect the Fed to cut rates twice this year, by 25 basis points each time, with the first rate cut in June and the second in September. However, several analysts believe that the evolution of geopolitical risks could make this expectation difficult to realize. Scott Anderson, Chief US Economist at BMO Capital Markets, warned that if the conflict continues, the Fed's next step could even turn to raising rates. Inflation pressure has already started to heat up before the rate cut Before the situation in Iran escalated, US inflation data had already shown signs of a tricky rebound for the Federal Reserve. Prices at the wholesale level have been accelerating since December last year, currently rising at an annual rate of 3%. Ethan Harris, former Chief Economist at Bank of America Securities, pointed out in a report published on LinkedIn that the increase in producer prices is likely to quickly consumer prices. Anderson stated that inflation appeared to be heating up in the first quarter of this year. The core Personal Consumption Expenditures (PCE) price index for January could rise to 3.1% on an annual basis, the highest level in nearly two years - and this was before the US potentially took action against Iran. The Fed's inflation target is 2%. He estimated that for every $10 increase in oil prices, consumer price inflation could rise by 0.2 to 0.4 percentage points over the next year. Given the $10 increase in oil prices so far this year, the impact should not be underestimated. "Just the increased risk of conflict with Iran is already impacting the energy market and prices, exacerbating US inflation pressures and creating significant obstacles for further rate cuts by the Fed," Anderson said. Tariffs and oil prices are both supply-side shocks, making monetary policy difficult to respond Economists point out that the unique aspect of this round of inflation pressures is that both tariffs and rising oil prices are supply-side shocks that directly increase production input costs. The Fed's interest rate tool mainly affects the demand side, stimulating or curtailing business and consumer spending to adjust the economy, with very limited effectiveness in cooling supply-side shocks. Brian Bethune bluntly stated, "In this situation, the Fed simply cannot cut rates." He said the core issue is that the Fed is finding it difficult to "put the brakes on" inflation. Anderson further warned that if the conflict turns into a prolonged war, there is a possibility that the Fed's next move could be an increase in rates rather than a cut. Analysts: Likelihood of US military action against Iran is high Many geopolitical and macroeconomic analysts believe that the likelihood of the US taking military action against Iran is increasing, which will be a key variable affecting the direction of oil prices. Suzanne Maloney, Director of the Foreign Policy Program at the Brookings Institution, pointed out that since January, the US has been gradually increasing its military presence in the Middle East. Christopher Granville, Managing Director of TS Lombard, said, "The likelihood of US military action against Iran seems to exceed 50%." Granville believes that even in the event of military confrontation, the likelihood of a global economic crisis and stagflation shock remains limited, but a scenario similar to the "soaring oil prices" after the outbreak of the Russia-Ukraine war in early 2022 cannot be ruled out - at that time, oil prices briefly surpassed $100 per barrel and remained at high levels for about six months. That shock was enough to drive US inflation significantly higher, with the core PCE price index rising to 5.6% on an annual basis in September 2022, nearing the highest level in nearly four decades. Currently, most bank analysts still predict that the average oil price in 2026 will remain in the low range just above $60 per barrel, but also acknowledge the difficulty in predicting the outcome of the situation in the Middle East. Iran's ability to respond is a key unknown factor The potential impact of Iran on oil prices not only depends on US military action itself but also on the direction of Iran's possible response. Karen Young, Senior Research Scholar at the Center on Global Energy Policy at Columbia University, pointed out that the magnitude of the spike in oil prices depends on whether Iran will strike neighboring countries' oil production facilities in response to US actions. In addition, Iran also has the ability to disrupt shipping in the Strait of Hormuz. The Strait of Hormuz is an important shipping route connecting the Persian Gulf, the Gulf of Oman, and the Arabian Sea, through which a significant amount of oil is transported globally. Vali Nasr, Professor of International Studies at the School of Advanced International Studies at Johns Hopkins University, believes that Iran is likely to choose to strike its neighbors. He said at a discussion event hosted by the Chicago Council on Global Affairs this week, that the Iranian government's assessment is that if Trump believes there is no cost to war, "he will continue to do so," and Tehran has the motivation to make a tough response. HSBC's latest research report also predicts that even if Iran briefly closes the Strait of Hormuz, Brent crude oil could quickly rise to $80 (currently $73). This article is sourced from Wall Street Vis. GMTEight Editor: Wang Qiujia.