The US-Iran conflict has triggered the largest oil supply shock in history, as oil prices and financial markets whipsaw on news and expectations of possible near and long term outcomes. Other markets affected include fertilizer (food supply), diesel (supply chains), and helium (chip production, AI hardware, medical machine cooling, etc.). As gas prices immediately spike, inflation concerns heighten and rate cut expectations evaporate.
Fed Chair Powell's recent comments indicated Fed patience with these price effects: "By the time the effects of a tightening in monetary policy takes effect, the oil price shock is probably long gone." This underscores the dilemma of Fed policy during a supply shock (as opposed to a "demand shock"). Supply shocks disrupt production, lower output, and raise inflation. The Fed can more easily manage a demand shock caused by consumer behavior. Those comments seem to cool some of the upward pressure on Treasuries; the 10-year Treasury is at 4.32% (after hitting the 4.45% level last week). Fed futures markets now predict no rate cuts this year, with the next cut not expected until September/October 2027 (40 days ago, rate cuts were expected to begin in June/July of this year).
Speaking of the Fed Chair, this month's Fed meeting is supposed to be his finale as Fed Chair, depending on the confirmation process for nominee Kevin Warsh. The Senate and White House are running out of time to agree on moving forward; this could ironically extend Powell's tenure as Chair. Stay tuned….
