Iran Conflict Boosts Inflation Threat
The Federal Reserve faces a dilemma on how quickly to raise interest rates as prices of key commodities stay high.
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President Trump has no good options on Iran. He can’t walk away. Invading is too risky. He’ll need to chart some kind of middle way that brings the Iranians back to the bargaining table and reopens the Persian Gulf to vital oil shipments.
We expect the fighting to continue with periodic cease-fires or talk of them. For now, the two sides are exchanging limited fire, which is intensifying but falling short of all-out war.
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Control over shipping has become the focus, as Iran claims that June’s cease-fire gives it authority over the critical Strait of Hormuz, while Trump says it must be open to commercial shipping. Neither side appears willing to budge on those positions for now. Meanwhile, Iran’s proxy force in Yemen, the Houthis, are attacking tankers in the Red Sea, where oil exports from Saudi Arabia are being rerouted to avoid Hormuz. The question now: Who is going to blink first?
Iran is taking a pounding after the cease-fire agreed to in June broke down amid attacks on ships that tried to pass through the strait, without complying with Tehran’s demand to use its designated route (or pay the tolls it likely demanded). But the regime can probably withstand a lot of punishment. It doesn’t answer to voters, and the fanatics who control its elite military forces certainly won’t care about civilian suffering as Iran’s economy craters. They just have to outlast Trump.
For Trump, the clock is ticking. Concerns of new oil shortages are mounting now that tanker traffic out of the Persian Gulf has fallen to a trickle. Early in the war, Washington and other governments eased supply concerns by releasing extra barrels stored in emergency reserves. Now, our Strategic Petroleum Reserve is running low, commercial stockpiles are getting whittled down, and there isn’t much buffer left.
Gas prices are rising again, back above $4/gallon for the national average. Diesel fuel could really soar, especially with Russia’s diesel exports shut down by Ukrainian drone strikes on Russian refineries. Costlier diesel adds to shipping costs and ultimately feeds into consumer prices, fanning inflation when it’s already too hot.
Ultimately, it seems that Trump is going to have to escalate or pull back, barring a sudden internal collapse of the Iranian regime. A decisive military victory may require a major ground invasion, which Trump hasn’t ruled out but seems wary of. Casualties would be severe. A limited invasion of strategic sites by U.S. special forces may be an option, though that would also risk heavier losses than we’ve taken so far. For all the damage Iran’s military has suffered, it still has plenty of missiles and drones to fire if Trump puts boots on the ground. His best bet may be to ramp up the bombing and hope Iran cracks before the economic and political stress on him gets too heavy.
This forecast first appeared in The Kiplinger Letter, which has been running since 1923 and is a collection of concise weekly forecasts on business and economic trends, as well as what to expect from Washington, to help you understand what’s coming up to make the most of your investments and your money. Subscribe to The Kiplinger Letter.
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