BREAKINGVIEWS-Gulf conflict has already laid a Fed trap

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Gabriel Rubin

WASHINGTON, April 8 (Reuters Breakingviews) - Gasoline prices shoot up like a rocket and come down like a feather. U.S. consumers and businesses have seen the first part of that formulation, with average pump prices spiking to $4.18 per gallon as of Wednesday, per the American Automobile Association. Despite the announcement of a fragile two-week ceasefire with Iran and the promise of safe Persian Gulf transit, relief will be hard to find, as high energy prices work their way through the rest of the economy as inputs for other goods and services. As the Federal Reserve learned in 2022, the inflationary effects from a global energy disruption will linger.

Policymakers repeatedly underestimated the difficulty and time needed to resolve supply snarls in recent years. The Biden administration and Federal Reserve each wrongly assumed pandemic-related supply shocks would be fleeting. An energy shock in 2022, caused by Russia’s invasion of Ukraine, led U.S. gas prices to exceed $5 a gallon and worsened inflationary pressures. The Fed eventually reversed itself, hiking rates by 4.25 percentage points that year.

If the Iran conflict moves towards a resolution, the Fed might have room to cut rates later this year. But with so much energy capacity destroyed — for example, Qatar’s liquefied natural gas output is estimated to be 17% lower over the next five years — it’s not likely.

Contrary to President Trump’s claim that prices will fall “rapidly,” economists are tracking how high energy prices will migrate into other consumer and wholesale goods. Bank of America economists project a 0.9% month-over-month jump in consumer prices in March, while core prices excluding food and energy are likely to rise 0.3%. In the coming months, that dynamic could flip. Energy costs would fall, but prices in petroleum product-dependent sectors, from transportation to manufactured goods, would rise.

The situation will be a cruel welcome for Kevin Warsh, the president’s nominee for Fed chair. If he is lucky, he will be dealing with a precarious ceasefire that holds 20% of the world’s fossil fuel in the balance, post-confirmation. At worst, he will be dealing with an extreme energy shock while resisting a president who wants rate cuts to shore up his political standing before crucial elections in November. Pulling back from the brink of an expanded conflict is welcome, but the resulting inflationary pressure is already baked in.

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CONTEXT NEWS

Oil tumbled below $100 a barrel on April 8 after U.S. President Donald Trump said he had agreed to a ‌two-week ceasefire with Iran, subject to an immediate and safe reopening of the Strait of Hormuz. WTI crude futures slid by $20.48, or 18.13%, to $92.47 a barrel by 1320 GMT.

The U.S. Personal Consumption Expenditure Price Index and the U.S. Consumer Price Index will be released on April 9 and April 10 respectively.

(Editing by Rob Cyran; Production by Pranav Kiran and Maya Nandhini)

((For previous columns by the author, Reuters customers can click on RUBIN/gabriel.rubin@thomsonreuters.com))