Rising oil prices rewrite inflation script; Federal Reserve rate cuts may be delayed until September

According to data released by the U.S. Bureau of Labor Statistics on Wednesday, the Consumer Price Index (CPI) in February increased by 2.4 year-over-year, a slowdown of 0.6 percentage points from the previous month. The core CPI, which excludes energy and food prices, rose by 2.5% year-over-year, unchanged from the previous month.

Analysts note that overall inflation in the U.S. for February was in line with expectations, but external threats—such as the surge in oil prices triggered by Middle Eastern geopolitical conflicts—are rewriting the inflation outlook. It is expected that energy costs will significantly boost CPI growth starting in March, and the Federal Reserve will face more difficult policy choices amid the shadow of stagflation.

Fitch Ratings’ U.S. Chief Economist Oulu Sonora told JiJie News that while the February CPI data initially appears reassuring, it may mask larger risks. He pointed out that from late January to early February, the U.S. federal government experienced another government shutdown due to partisan disagreements over immigration enforcement. This brief shutdown could have affected the Bureau of Labor Statistics’ housing data collection, leading to delays or missing data, which may have resulted in a lower CPI reading for February.

“But more importantly, the February data has not yet reflected the ongoing dramatic changes in energy prices,” Sonora said.

Since March, under joint U.S.-Israel efforts, the situation in Iran has rapidly escalated, leading to disruptions in shipping through the Strait of Hormuz. This strait carries about a quarter of the world’s seaborne oil trade, and markets are generally concerned that the risk of oil supply disruptions will continue to grow. Although the International Energy Agency (IEA) recently announced that member countries agreed to release emergency oil reserves, it has not yet curbed the rise in oil prices.

As of noon on March 12 Beijing time, Intercontinental Exchange Brent crude futures were around $101 per barrel, up 38% from the last trading day before the conflict (February 27).

Stephen Brown, North America Deputy Chief Economist at Kantar Macro, told JiJie News that the surge in energy prices will soon feed into inflation data. “If oil prices stay at current levels, the March CPI year-over-year will jump by 0.5 percentage points to 2.9%,” he said. He also noted that AAA data shows the average gasoline price has risen to $3.58 per gallon, the highest in over 21 months.

Analysts believe that if the Iran conflict continues, it could lead the Federal Reserve to delay further interest rate cuts.

Latest data from the CME FedWatch Tool shows that the probability of the Fed holding rates steady in March exceeds 98%, with the first rate cut now expected not before September, pushed back from June before the Iran conflict escalated.

Analysts say that the impact of rising oil prices on U.S. inflation occurs on two levels: first, directly increasing energy prices, which quickly reflects in overall CPI; second, through cost transmission gradually permeating core inflation, affecting the core Personal Consumption Expenditures (PCE) Price Index that the Fed monitors more closely.

Sonora pointed out that for the Fed, the real focus is on core PCE. Rising energy costs will push up transportation, manufacturing, and other sector costs, ultimately reflected in core goods and services prices. “This indicator is still running close to 3% year-over-year. If the Iran conflict pushes energy prices higher and this feeds into core inflation, inflation risks will remain persistent,” he said.

What makes the Fed even more concerned is that oil prices are soaring at a time when the labor market is showing signs of fatigue.

Last week, the U.S. Bureau of Labor Statistics reported that non-farm payroll employment decreased by 92,000 in February, and the unemployment rate rose by 0.1 percentage points to 4.4%.

Puyi International Chief Macro Analyst Jin Xiaowen told JiJie News that the much weaker-than-expected February employment data indicates that the labor market has not yet recovered. Coupled with an upcoming inflation rebound, this suggests the Fed will face a classic stagflation scenario—slowing economic growth alongside rising inflation risks.

Seema Shah, Chief Global Strategist at Principal Asset Management, also said that the slowdown in the labor market and rising inflation are pushing the U.S. economy toward stagflation, which is concerning for markets already dealing with various negative factors.

Analysts point out that in the coming months, the Fed’s policy path will depend on three key questions: How long will oil prices stay high? Will energy prices transmit into core inflation? And in the context of a weakening labor market, can the Fed withstand the dual pressures of stagflation?

Sonora stated that the Fed can currently only wait—wait for the geopolitical conflict to clarify, wait for the effects of oil price transmission to become clear, and wait to see whether inflation or the labor market presents a greater risk. In this complex game, the oil tankers in the Strait of Hormuz may be more decisive for the future of the U.S. economy than the Fed’s dot plot.