How the Israel-Iran conflict could hit the economy

Politico

4 hours ago

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As the U.S. weighs intervention in Israel's conflict with Iran, Wall Street has been skittish, eyeing the potential fallout for oil prices and inflation.
To get a better sense of what's driving the oil market and what economic risks might lie ahead, MM caught up with Rory Johnston, an oil market analyst at research service Commodity Context who's been following all of this closely.
A takeaway from that conversation: The price jump has been notably large for a market that has become desensitized to political risks after safely weathering multiple shocks over the last few years, including Covid and the Russia-Ukraine war.
Now, 'even a numb cynical oil market sees Israel bombing Tehran and says, 'OK, maybe worry a bit here,'' he said.
Conflict with Iran is the 'No. 1 risk scenario that people talk about, and now we're living in it,' he added.
A worst-case scenario would be if Tehran is driven to close off the Strait of Hormuz, a channel through which about a fifth of the world's oil passes. Experts including Johnston say it's unlikely Iran would do that unless pushed to the brink — such a move would run the risk of hurting its own economic lifeline, as well as antagonizing its neighbors in the region — but the shockwaves would be significant.
For now, what struck your host is that this conflict is helping prop up prices at a time when they'd really started to drop, and that could help boost U.S. oil production, which had previously been forecast to contract in 2026. But the exact trajectory of all this is highly unclear.
'This is usually the lead-up to summer driving season, so gasoline prices were set to rise anyway,' POLITICO's resident oil market expert Ben Lefebvre told MM. 'Because of the current Middle East situation, they'll rise further than they might have when oil was still around $60 a barrel. But when compared to what U.S. drivers experienced even last year, it won't be too far off recent norms … if there is such a thing as 'recent norms.''
'The interesting thing is whether this spurs U.S. oil companies to drill more,' he added. 'They might just see this as a temporary boost and not something they want to get too far ahead of.'
Rewind to before the current Israel-Iran conflict escalated. OPEC, the cartel of major oil-exporting countries, had been holding back production but then ramped up output earlier this year. That move was taken, in part, to get ahead of the effects of President Donald Trump's tariffs, which had raised fears that demand for oil would crater amid a global slowdown.
That was leading to forecasts of oversupply later this year, Johnston said, reducing incentives for oil companies to produce.
Now, Israel's attacks on Iran have likely led to fear-buying, as well as speculative trading, that has pushed up prices as much as 15 percent. Fighting so far has spared infrastructure that would significantly crimp the outflow of crude.
'While theoretically on its face, nothing that's happened so far has changed anything physical about supply and demand, part of the way … price formation has occurred is you have physical participants — a refinery, whatever — that's all of a sudden worried they're not going to be able to get cargos next month or the month after,' Johnston said.
For prices to stay high or go higher, there likely would have to be some actual damage to key oil infrastructure, he said. But in the meantime, the scope for economic disruption is still significant. The largest price increases have been for diesel, a key input for shipping and therefore a potential risk to inflation in many sectors.
'It might not seem as harsh at the pump, but your shipping and your route delivery is going to feel the pinch of diesel far more,' Johnston said.
More broadly, John Fagan, co-founder of Markets Policy Partners and the former markets head at the Treasury Department, said this oil price shock feeds the narrative that the U.S. is going to have slower growth and higher prices: stagflation.
'Demand is not collapsing, and oil prices are not unbelievably high, so you don't have that pop and drop kind of dynamic' when prices rise above where the market can support, he said. 'And if the dollar can't rally, that's supportive of [higher] oil prices.'
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The Economy
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In fact, projections from the central bank's policymakers suggest they're less confident they will be able to significantly decrease rates than they were in March.
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Jobs report
Carolyn Davis is now director of comms at Better Markets. She previously was director of external comms at Leadership for Educational Equity.
Mike Spratt has joined the ICI as an associate general counsel. He previously was assistant director in the Division of Investment Management Disclosure Review office at the SEC. He also served as counsel to former SEC Commissioners Kara Stein and Elisse Walter.