Key Takeaways
- Economists see rising risks to inflation and the job market as the war in Iran continues to disrupt energy supplies.
- The events have parallels with, and significant differences from, the oil shock of the 1970s that led to “stagflation.”
- Economists said the economic shock to inflation and economic growth could fade if the war ends quickly.
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War in the Middle East, surging oil prices, and a stagnant labor market: The economic situation is starting to feel like the 1970s.
The outlook for the economy worsened over the weekend as the U.S. and Israel continued to strike Iran. Iran kept the Strait of Hormuz virtually closed, bottling up some 20% of the world’s crude oil supply. Fears grew that the war and its disruption to energy supplies could drag on, as leaders on both sides of the conflict showed no signs of backing down.
The prospect of a prolonged war raised the chances of the U.S. experiencing a period of high inflation and slow economic growth called “stagflation.” The last major bout of stagflation took hold in the 1970s during all-too-similar conditions, when a conflict between the U.S. and Iran caused energy prices to skyrocket. Whether stagflation takes hold again depends on how long the current war goes on, economists said.
“The U.S. economy now faces its second stagflation-like shock inside a year,” Sal Guatieri, senior economist at BMO Capital Markets, wrote in a commentary. “On the heels of the trade war, the Iran war will lift inflation and bond yields, disrupt energy supply chains, rattle investor and business confidence, and weaken global demand.”
What This Means For The Economy
Stagflation reduces living standards for consumers by hurting the job market, which reduces incomes, and raises prices, reducing the dollar’s buying power.
Economists expect the war to both to lift prices and damage a job market that was already weakening and lost 92,000 jobs in February before the war began. Based on oil prices, the national average for gallon of gasoline is likely to rise to $4 from $3 prewar, forecaster at Pantheon Macroeconomics estimated.
“Drivers soon will be paying $4 per gallon for gas, squeezing real disposable income and hitting jobs,” Samuel Tombs, chief U.S. economist at Pantheon, wrote in a commentary.
Economists at Deutsche Bank said there were a number of differences between today and the 70s, when inflation surged into double-digits, gasoline was rationed, and the economy plunged into several painful recessions.
For one thing, the U.S. is now a major producer of crude oil in its own right. For another, consumers expect lower price increases in the future, reducing the risk of a wage-price spiral turbocharging inflation.
“Clearly whether history repeats itself all depends on how long this conflict lasts,” Jim Reid, global head of macro research at Deutsche Bank wrote in a commentary.
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The rising risks to consumer prices and the job market could put officials at the Federal Reserve in a dilemma as they pursue the central bank’s dual mandate to keep both inflation and unemployment low. Even before the war, Fed policymakers were divided about whether to keep the fed funds rate higher for longer to fight inflation, or lower it significantly to encourage hiring.
“Some officials may argue for looking through a supply shock and supporting a weakening labor market. Others may warn against repeating past mistakes by easing too early,” Daniella Hathorn, senior market analyst at Capital.com, wrote in a commentary. “The likely result? A more divided Fed, greater policy uncertainty, and increased volatility across both bond and equity markets.”
One person apparently unconcerned about the spike in oil prices was President Donald Trump.
“Short term oil prices, which will drop rapidly when the destruction of the Iran nuclear threat is over, is a very small price to pay for U.S.A., and World, Safety and Peace,” he posted on social media Sunday. “ONLY FOOLS WOULD THINK DIFFERENTLY!”
Indeed, some economists saw a possibility of things returning to normal—if the war ends quickly. Reid noted that oil markets “aren’t pricing in a sustained shock,” with oil futures 12 months ahead trading at $75 a barrel.
And forecasters at Oxford Economics kept their forecast for interest rates and equities unchanged, predicting the S&P 500 stock index would reverse its recent downturn once the war ended.
“The impact on U.S. GDP and inflation should be modest,” John Canavan, lead analyst at Oxford Economics, wrote in a commentary, “assuming a limited military campaign.”