What the oil surge means for the Fed’s path forward

The surge in Brent oil prices above $100, now sustained for over a week, has shifted the macro narrative from a temporary geopolitical shock to a potentially persistent inflation risk. While markets remain split, with equities signalling resilience and rates pricing caution, the Federal Reserve faces a more complex trade-off between supporting growth and containing inflation. Although our base case still anticipates rate cuts later this year, elevated energy prices are eroding confidence in that outlook.

A severe disruption to Middle East energy flows has delivered a historic supply shock. Transit through the Strait of Hormuz - accounting for roughly 30% of global seaborne oil - has effectively halted. Brent crude oil prices have surged, holding near or above $100 for more than a week. This shock is proving far more persistent than initially anticipated.

Market reactions have been uneven. U.S. equities have shown relative resilience, reflecting the economy’s lower sensitivity to higher oil prices as a net energy exporter. By contrast, rates markets have repriced more forcefully, with higher yields reflecting a reduced probability of Fed rate cuts. International markets, particularly in Europe and Asia, have faced greater pressure given their heavier reliance on imported oil and gas.

For the Federal Reserve, the energy shock has raised inflation risks at a time when the labour market is showing signs of weakness. While the Fed typically looks through energy price spikes, sustained oil prices at elevated levels risk de anchoring inflation expectations, especially after several years of above target inflation, complicating the path to policy easing.

Our base case still expects rate cuts later this year, but confidence in that outlook is fading. If energy prices remain elevated, the Fed’s tolerance for easing will likely diminish, raising the risk that further cuts fail to materialise and leaving the policy path materially more uncertain.