Following the outbreak of conflict involving Iran on February 28th, ripple effects across energy markets and supply chains are gradually materializing. Federal Reserve officials warned on Wednesday that the ongoing U.S.-backed conflict involving Iran is increasing the risk of prolonged high inflation by driving up oil prices and disrupting global logistics systems.
Chicago Fed President Austan Goolsbee, speaking to media via video after an event at the Milken Institute in Los Angeles, noted that while businesses were initially unconcerned about short-term oil price increases, sustained high prices over several months would create significant pressure on supply chains. He relayed feedback from corporate executives indicating that if high oil prices persist month after month, they would begin to feel considerable strain from supply chain disruptions.
Goolsbee pointed out that these emerging signs share similarities with the factors that drove the inflation surge during the COVID-19 pandemic.
He further explained that over time, problems accumulate as businesses deplete stocks of industrial chemicals and other critical inputs, while related distribution systems face disruptions. Simultaneously, elevated fuel costs are progressively filtering through to shipping and other sectors. "You start to see these issues building," he stated.
Although the initial conflict sparked concerns about "stagflation"—a scenario combining weak growth and rising prices—Goolsbee believes this situation has not yet materialized. "This is not a stagflationary shock at this point. It's an inflationary shock. If it persists, I would become increasingly concerned," he commented.
With inflation already running approximately one percentage point above the Fed's 2% target and markets anticipating potential further increases, investors widely judge that the Federal Reserve has very limited room to cut interest rates over the next year or longer.
Inflation Risks Dominate Policy Discussions
St. Louis Fed President Alberto Musalem, speaking at an event hosted by the Mississippi Bankers Association in Fairhope, Alabama, stated that the primary risk for current policy has shifted toward upside inflation risks. He indicated that interest rates may need to remain unchanged "for some time," and did not rule out the possibility of further increases.
"Inflation is running notably above our target," Musalem stated, emphasizing that uncertainties exist for both employment and prices, but the balance of risks is tilting toward inflation. "My sense is that risks have been shifting toward the inflation side," he added.
He also mentioned that while rate cuts remain a "reasonable scenario" should demand weaken and unemployment rise, rate increases are equally plausible in the current environment. "There is significant uncertainty right now; the key is how things settle."
Musalem further noted that current price pressures are no longer confined to the direct impacts of tariffs or energy price increases driven by Middle East conflicts, but are showing signs of broader diffusion. Feedback from businesses indicates that rising prices for key industrial inputs such as aluminum, helium, and diesel "will all be damaging... There is also a confidence effect," which could dampen hiring intentions even as costs rise.
Domestic energy costs in the U.S. have risen significantly. According to data from the American Automobile Association (AAA), the average price of gasoline has climbed from around $3 per gallon to over $4.50.
Supply chain pressures are also intensifying. The Global Supply Chain Pressure Index published by the New York Fed has risen to its highest level since July 2022, a period when global manufacturing systems were still heavily impacted by the pandemic and widespread price increases.
Interest Rate Path Under Reevaluation
At the policy level, the Federal Reserve may be forced to maintain current interest rates for a longer duration. The federal funds rate has remained in the 3.50% to 3.75% range since last December, interrupting previous market expectations for sustained policy easing and complicating efforts for incoming Fed Chair Kevin Warsh to fulfill President Trump's expectations for rate cuts.
Although neither Musalem nor Goolsbee currently holds a vote on interest-rate decisions, their comments align with the "core" inclination previously mentioned by Fed Chair Jerome Powell, indicating a growing internal acceptance of the potential need to raise rates to counter inflation risks if necessary.
Recent data also shows signs of resurgent inflation. For instance, the Personal Consumption Expenditures (PCE) price index, a key gauge for the Fed, showed its annual rate rise from 2.8% to 3.5% in March. The core measure, which excludes volatile items like energy, increased from 3.0% in February to 3.2% in March.
Subsequent data releases are being closely watched. The upcoming Consumer Price Index for April is anticipated to show a further increase. A Reuters survey of economists suggests the unemployment rate is expected to hold steady at 4.3% in Friday's non-farm payrolls report for April.
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