Disruption of oil flows through the Strait of Hormuz could send energy prices soaring globally. We are closely monitoring developments, though our base case is a minimal economic impact from the conflict, especially with the Federal Reserve able to support growth with rate cuts.
Markets taking wait-and-see approach
The market’s reaction this past week to missile and drone strikes between Israel and Iran has been relatively tame, with the S&P 500 falling 1% on June 13 on the initial news before bouncing back the Monday. On Saturday (June 21), the U.S. engaged in a limited action that targeted three Iranian nuclear sites. For now, we believe the economic impact of the conflict remains minimal. Investors don’t appear to be making huge bets, preferring instead to monitor the evolving situation.
Risks of disruption to global energy supply
The greatest near-term threat is potential volatility in energy markets. Crude oil has traded within a $58-85 range over the past 12 months, rising nearly 10% since Israel’s initial strike.1 More than 20 million barrels of oil pass through the Strait of Hormuz every day, representing roughly 20% of global daily oil flows. A disruption could cause energy prices to soar. But as of this morning, the market does not expect a disruption to this transportation lane.
While higher oil prices could strain the U.S. economy, we estimate that they would need to increase significantly—to around $120 per barrel—to trigger a recession. Despite the heightened uncertainty from this conflict and tariffs, underlying economic indicators, such as labor market strength, suggest that the economy remains healthy.
The Fed could step in if economic conditions deteriorate
The path of interest rates may also be affected by this escalation. Before these strikes, the market expected the Federal Reserve to cut 50 bp this year. While a higher oil price could drive headline inflation, the extent of the move is unlikely to be large enough to push inflation expectations meaningfully higher. Furthermore, the Fed’s primary inflation gauge of core PCE excludes energy, and it tends not to react to short-term price fluctuations. Instead, we think the path of cuts is predicated more on weakening labor markets than rising inflation. We expect the first cut may take place at the September meeting. According to the Fed’s most recent Summary of Economic Projections, the long-term neutral rate is expected to settle at around 3.00%.2
If the conflict expands to include more countries or if further aggressive acts occur, there is potential for meaningful volatility.
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