Fed officials warn U.S.-backed war with Iran raises risk of persistent U.S. inflation

The Federal Reserve is back in a bad old place — worrying that an oil shock won’t stay “just energy” for long. That matters because the Fed can usually look through a temporary jump in gasoline prices. But this time officials are talking about something broader: shipping costs, industrial inputs, inflation expectations, and a policy path that may need to stay tight longer than markets wanted. The shift became explicit again on May 6, when St. Louis Fed President Alberto Musalem said the risks had moved toward higher inflation. ### What changed this week? Musalem said the balance of risk has tilted toward inflation, not employment, and that the Fed may need to keep its policy rate on hold for some time. He also said there are still plausible paths to either cuts or hikes, which is Fed-speak for: stop assuming the next move is down. His point was that inflation is still meaningfully above target, while the job market has not weakened enough to force the Fed’s hand. ### Why does Iran matter to U.S. inflation? Because oil is the first domino, not the last one. The Iran conflict disrupted energy production and transportation in the Middle East and raised the risk of a longer supply shock if the Strait of Hormuz stays impaired. Fed Governor Christopher Waller said in an April 17 speech that a prolonged disruption there could have a lasting effect on both inflation and U.S. growth. ### Isn’t the Fed supposed to ignore oil shocks? Usually, yes — if they fade quickly. The catch is persistence. Musalem said the pressure is moving beyond tariffs and crude itself, with businesses reporting higher costs for aluminum, helium, diesel fuel, and other inputs. He also pointed to a New York Fed supply-chain gauge hitting its highest level since July 2022. ### How big is the inflation hit? Dallas Fed researchers put numbers on the “current scenario” in an April 17 note. They estimated the 2026 Iran war would raise fourth-quarter-over-fourth-quarter headline PCE inflation by 0.6 percentage points and core PCE by 0.2 points. That sounds modest, but core inflation was already running too hot. Reuters’ May 6 summary of the latest data put March core PCE at 3.2%, up from 3.0% in February. ### Why are some Fed officials talking about hikes again? Because if energy stays high long enough, the Fed may have to defend credibility, not just growth. Minneapolis Fed President Neel Kashkari said on May 1 that a prolonged closure of the Strait of Hormuz could warrant “potentially a series” of rate increases. He noted oil had risen above $100 a barrel for weeks and touched $126, versus about $70 at the start of the conflict. ### Where does fiscal policy fit in? It makes the whole setup less forgiving. Treasury’s latest quarterly refunding documents were released May 6, and the Treasury Borrowing Advisory Committee said uncertainty has risen significantly because of higher energy prices. CRFB said the same batch of documents points to an FY 2026 deficit if inflation stays elevated. ### So what’s the real takeaway? Basically, the Fed is no longer treating this as a clean, temporary gas-price story. Officials are signaling that war-driven energy disruption could bleed into core inflation and keep rates higher for longer. That does not guarantee hikes. But it does mean the old assumption — that the next move is a cut — looks a lot less safe now.