Financial markets were volatile this week amid uncertainty on the duration of the Middle East conflict. The S&P 500 traded lower initially but rebounded mid-week on signs of de-escalation in the U.S.–Iran conflict. Treasury yields and crude prices also eased on the news, though the reprieve was brief. Like Artemis II, Trump’s speech on Wednesday night sent oil prices to the moon again on Thursday morning. While Trump reaffirmed a 2–3 week timeline for ending U.S. military involvement, he dashed hopes for a peace deal, promising to hit Iran “extremely hard”, and said that re-opening the Strait of Hormuz was not a U.S. goal. 

Even if the U.S. reduces its military attacks soon, oil prices could stay high: ramping up production and repairing infrastructure takes time, and supply risks persist if the Strait of Hormuz remains closed or below capacity. Inflationary risks are tilted upward even as our latest report notes the latest oil shock is unlike the one in 2022 in some ways. This shock is more concentrated in oil, with natural gas and agricultural commodity prices contained.

The economic backdrop is also different. Supply chains weren’t strained before the latest price shock, the labor market has cooled, and the economy isn’t firing on all cylinders. Still, with gas prices rising to $4/gallon this week, and signs that the conflict is adding pressure to other commodities, higher inflation is in the cards (Chart 1). This week’s data showed households’ inflation expectations jumped in March.

This is the fourth price shock to hit households in five years, arriving amid a slowing labor market. JOLTS data showed hiring declined in February, while job openings and layoffs were steady but low, suggesting the labor market remains in a low-hire, low-fire mode. Markets expect payrolls to rise by 65k in March, similar to the ADP print, and a partial rebound after an unexpected loss of 92k jobs in February. While not yet signaling a sharp deterioration, a cooling labor market leaves households more exposed to negative shocks.

Consumer spending has stayed relatively resilient, but households are inflation-weary and showed caution even before the latest surge at the pump. Retail sales rose 0.6% m/m in February after two months of stagnation (Chart 2). Adjusted for inflation, sales volumes are up only 1% from a year ago. Larger tax refunds may help mitigate higher gas prices, but slower hiring and equities selloff could still weigh on consumption.

With stagflation fears surfacing, the Fed faces a tough balancing act. So far, it seems content to stay on hold. Earlier this week, Fed Chair Powell said oil shocks are typically short-lived and the Fed can remain patient; however, he noted the Fed would act if inflation expectations shift. NY Fed President Williams said, “the current stance of monetary policy is well positioned to balance risks to our maximum employment and price stability goals.” However, if you chase two rabbits, you likely won’t catch either. Let’s hope the Fed doesn’t find itself in that spot.