Any chance of a Fed interest-rate cut in 2026 is 'evaporating before our very eyes' with Iran war set to stoke oil prices

By Greg Robb

U.S. and Israel strike several locations in Iran, which responds with missile attacks on Gulf nations

President Donald Trump greeted members of the Joint Chiefs of Staff as he arrived to deliver his State of the Union address on Tuesday.

War with Iran is expected to lead to a spike in oil prices, which, if prolonged, could mean the next move by the Federal Reserve is to raise interest rates.

President Donald Trump has called for regime change in Iran. Experts said one of the largest-scale concerns is that this Iranian regime will see its very existence at stake.

The Iranian regime "is going to do whatever they can and whatever they believe will help them stay in power," said Suzanne Maloney, director of the foreign-policy program at the Brookings Institution, speaking at a Chicago Council on Global Affairs event this week. "That does include striking both their neighbors, against energy infrastructure in the region, and, of course, against Israel and the U.S. military and any other presence in the region.

"It could be a very dangerous time in the aftermath of American military action in Iran."

For the U.S. economy, meanwhile, it seems certain that war will push the inflation rate higher.

"The argument for having lower rates is just evaporating right before our very eyes," said Brian Bethune, an economist at Boston College, in an interview with MarketWatch. The uptick in oil prices combined with the Trump administration's aggressive approach to tariffs will keep prices high.

See: After the U.S. and Israel attack Iran, bitcoin and oil are offering glimpses into the broader response of markets

Over the past several months, the Fed has struggled to tamp down inflation amid pressure from the White House and the markets to cut rates. These latest developments in the Middle East only add to the central bank's challenges.

Prices at the wholesale level started to accelerate in December and are now running at a 3% annual rate, frustrating Federal Reserve officials who had hoped that Trump's new levies on imports would have only a transitory impact on inflation. It's likely that the increase in producer prices will soon be passed on to consumers, said Ethan Harris, former chief economist at BofA Securities, in a note on LinkedIn.

Inflation is looking like it's heating up in the first quarter, agreed Scott Anderson, chief U.S. economist at BMO Capital Markets. Core personal-consumption expenditures could rise to a 3.1% annual rate in January, the highest rate in two years - and that's before any impact from the strike on Iran and its repercussions. The Fed's annual target for inflation is 2%.

Any $10 increase in crude-oil prices is estimated to raise consumer-price inflation by 0.2% to 0.4% over the coming year, Anderson said.

WTI crude-oil futures (CL00) (CLJ26) are up about 16% to date in 2026, or $10 per barrel.

Oil prices were already rising as tension with Iran was rising, and now a prolonged conflict might raise the possibility that the central bank's next move would be to raise interest rates, Anderson added.

"You're really talking about problems for the Fed in terms of putting a lid on inflation," Bethune said. "In this situation, the Fed can't lower rates."

Traders in derivate markets still expect two quarter-point rate cuts this year, with the first coming in June and the second in September.

Both tariffs and oil prices are supply shocks, raising the costs of inputs into production of the economy, which are very hard for the Fed to cool.

The Fed's interest-rate tool kit works more on the demand side of the economy, by either spurring companies and consumers to spend or nudging them to pull back.

Oil prices to spike as Iran hits neighbors

Oil prices are expected to spike now that Iran's missiles have hit other Gulf states.

Iran has the ability to disrupt the flow of oil through the Strait of Hormuz, a crucial maritime passage connecting the Persian Gulf with the Gulf of Oman and the Arabian Sea.

Christopher Granville, managing director of TS Lombard, a macroeconomic forecasting consultancy firm based in London, said a military confrontation between the U.S. and Iran is unlikely to send the global economy into a full-blown oil crisis or stagflationary shock. Still, it's possible we'll face an "oil squall" similar to what happened after Russia invaded Ukraine in February 2022, when oil prices surged over $100 a barrel and remained high for six months.

That so-called squall was enough to fuel inflation in the U.S., with the core PCE price index rising at an annual pace of 5.6% in September 2022, its highest rate in almost 40 years.

Karen Young, senior research scholar at the Center for Global Energy Policy at Columbia University, said any price spike depends on whether the Iranian regime strikes oil-production facilities of its neighbors in the Middle East in response to the U.S.-Israel action.

Vali Nasr, a professor at the Johns Hopkins University's School of Advanced International Studies, had said it was likely that Iran would hit its neighbors.

For as long as the Iranian regime holds out, said Granville, the "squall risk" will persist, pointing to a sticky risk premium in oil prices and, in effect, putting a floor under what would otherwise be fundamentally driven weakness.

During whatever time span is required for U.S. military power to neutralize Iran's defense capabilities, the oil price spike would endure, but that same "whatever it takes" response, according to Granville, would prevent any Iranian action setting ablaze the whole of the Gulf and precipitating a full-blown, 1970s-style oil crisis.

-Greg Robb

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02-28-26 0922ET