The economic fallout of the Iran war

0:01Myles McCormick: The economic toll of the war with Iran is already showing itself. Oil prices shot back up to over$100 a barrel overnight as Iran focuses more of its attacks on fuel. The Trump administration is bent on telling markets one thing. We took a little excursion because we felt we had to do that to get rid of some evil. And I think you'll see it's going to be a short-term excursion. And Iran, another.

0:27Sam Fleming: As we end this threat to America and this threat to the world, we don't want to leave early, do we?

0:57Myles McCormick: G2. Hey, Miles. Hey, Mark. And we've also got Sam Fleming, the FT's economics editor. Welcome, Sam. Hi, Mark. Let's start by talking about the oil market, which is obviously the big story coming out of all this. What a week it has been for that. Brent has crossed over$100 a barrel again on Thursday. Miles, how did we get here? It's been a pretty hectic week, all right. In terms of how we got here, there seems to be this wild miscalculation by the US. You've had these. US-Israeli strikes on Iran on the assumption that Iran would fold reasonably easily. But Iran has played its one trump card, which is shutting down this key transit passage in the Gulf called the Strait of Hormuz, through which about a fifth of global oil flows that has curbed supply to global markets and sent prices spiraling.

1:47Myles McCormick: And we've had this kind of mad dash over the past week by the US and its allies to try and bring prices back under control by pulling various levers they have at their disposal, which have had some impacts on the markets. But oil still remains seriously elevated. I mean, at the time of recording, it's in around the 100 mark up from the low 70s before the conflict broke out. And this is going to have serious economic ramifications from the price motorists are paying for petrol slash gasoline to what farmers are paying for diesel to what airlines are paying for jet fuel. So the ripple effects are going to cast across the global economy for quite a while to come.

2:32Myles McCormick: Always nice of you to translate petrol into gasoline for me, Miles. That's very kind to cater to the American. I try to do my best for our American listeners.

2:40Sam Fleming: But it's not only, of course, it's not only oil and gasoline slash petrol is also natural gas. And I suspect that's an area where the story is playing quite differently where I am in Europe versus in the United States, US being a net exporter of natural gas as well as oil, but having a fairly, being almost like a gas island where natural gas, you know, there isn't a huge amount being exported. And so it's slightly less exposed to the global price. And so natural gas prices haven't moved as much in the US as they have in other parts of the world. And that is a result, the fact that the strait is not only an important transit point for crude oil, but an incredibly important transit point for LNG.

3:19Sam Fleming: And that is driving up LNG prices in Europe and in Asia and other parts of the world which are exposed to that. And that is a massive story on top of prices at the pump. There's also the issue in these economies about surging prices of power because natural gas is such an important input into power generation around the world as well. So it's really on multiple fronts that this energy shock is playing out.

3:47Myles McCormick: I want to move on to other markets because they're just as important as the oil market. We're going to get there in a second. But first, I want to talk about the Trump administration's messaging. It seems to be particularly attuned to how volatile the market is and kind of tailoring messages about an end to the war exactly when prices are shooting up. Is that messaging working? Not really, in a nutshell. I mean, yeah, like there's various steps, as I was saying, that have been taken to kind of try and tamp down on prices, not least this kind of massive release of crude and petroleum from global reserves over the past week, biggest on record.

4:23Myles McCormick: it. But prices, after kind of oscillating a bit, are still rising. And the Trump administration, conscious of the political ramifications of this, conscious of what angry motorists means in an election year, is trying its best to be seen to be combating the rise in prices. And Trump has sent out his various lieutenants during the week to speak about the efforts that are being taken. But the messaging's been messy. I mean, Chris Wright, the Energy Secretary, put out this tweet during the week saying that the US had used its navy to escort a commercial vessel through the Strait of Hormuz and then rapidly deleted us, since apologised and said he's got his messaging mixed up.

5:09Myles McCormick: But there seems to be a sense of panic within the administration, a sense that messaging isn't really being coordinated between the White House and the various wings of government. Yes, I was made aware of this post. I haven't had a chance to talk to the energy secretary about it directly. However, I know the post was taken down pretty quickly, and I can confirm that the US Navy has not escorted a tanker or a vessel at this time. And that's just leading to a lot of confusion in markets, which means that oil has been more volatile than we've seen almost ever. I mean, the highs and lows that it's hit in individual days has been barely precedented because traders are just struggling to kind of work out the duration and seriousness of this conflict and what it's ultimately going to mean for energy and other markets in the long run.

6:03Myles McCormick: I want to talk about some other markets because we've seen this play out in other places in a really interesting way in the sense that stocks have been hit, but not as bad as maybe sovereign bonds. And I want to talk about why that is. Sam, why are we seeing, you know, U.S. treasuries and gilts get hit as hard as they are?

6:23Sam Fleming: I mean, this is an inflation story, and it's partly, I guess, a question about how central banks respond to this. So we were in a disinflationary period around the world. Inflation may not have been exactly where people wanted to see it, but it was certainly coming down. And in example, in the Eurozone, it was basically where the central bank wants it to be. And instead now we have this price shock and that is forcing investors to reappraise the outlook for short-term interest rates, which is definitely impacting the bond markets. And you can see that, for example, with investors now pricing in an increase in interest rates by the European Central Bank this year, which wasn't the view before.

7:05Sam Fleming: They're starting to put some odds on the Bank of England increasing interest rates, although not fully pricing it in the next year or so. And they've dialed back some of their expectations on Federal Reserve rate cuts, although still the central expectation there is the Fed will be able to cut because the US is slightly less exposed to the inflationary consequences of this energy price shock than other markets. So that is part of what is driving the movement in bond prices. There's the enormous uncertainty as to the duration of this conflict and the duration of the disruption. And even if the Trump administration feels it might be able to say we're nearly at an end, or we'll see, as Miles says, the messaging varies sharply, but say, if their overall message is an end is in sight in terms of this, it's not actually in their gift entirely in the end of this conflict.

7:56Sam Fleming: It's still perfectly possible for Iran, as it's currently proving to create ongoing disruption to the Strait of Hormuz, even if the U.S. thinks it's achieved whatever the goals are that it thinks it's trying to achieve here.

8:09Myles McCormick: I'm really glad that you brought up monetary policy because we got an inflation report from February this week, and it went directly into the garbage, right? It was completely disregarded. Inflation was within line of expectations, and it doesn't matter anymore because we have this inflation shock that you just mentioned. And then we have the Federal Reserve meeting next week. And I'm curious how you see them, Sam or Miles, factoring this into their monetary policy plan.

8:36Sam Fleming: I think, well, it's not actually, it's not only the Federal Reserve. There's a whole swath of central banks. Oh, that's right. I'm sorry.

8:42Myles McCormick: I didn't mean to leave out all the others, but let's start with the Fed.

8:44Sam Fleming: I mean, it doesn't always happen, but we have a kind of blockbuster week next week for central banks.

8:49Myles McCormick: ECB, Fed, BOJ, and BOE. Yeah.

8:51Sam Fleming: The VOE, there's a whole bunch of them. Very exciting for us monetary policy geeks. Kind of, yeah, Christmas or whatever the right expression is. But anyway, it's all happening on central banking next week. And of course, the timing is brilliant because we can actually hear the first responses, proper formal responses from the central banks to what's going on in terms of the Middle East crisis. Now, so the calibration is going to be pretty difficult. If this suddenly stopped and commodity prices tumbled, potentially central banks could view this as a temporary spike, but one that reverses quite quickly and they don't have to worry too much about it.

9:31Sam Fleming: But there's a lot of history here and there's a lot of recent history. And the recent history is that talking about transitory price shops.

9:38Myles McCormick: The T word, transitory. The T word, exactly.

9:41Sam Fleming: I would be very surprised if we hear a lot of transitory from central banks next week. they got pretty burned back in 2021-22 by believing that the energy price shock and the price shock that followed the reopening of economies after the pandemic was just going to be a transitory thing they could look through. Turned out that actually it wasn't that transitory and we had inflation in some countries going up to double digit levels. So they're burned by that and they're going to, I think, I suspect sound a lot more cautious. But ultimately, it's very difficult for them to give strong and clear outlooks in terms of where policy is going to go right now because they have very little visibility on the duration of the conflict, crucially, and the duration of the supply chain disruptions, which are spreading out across multiple commodity markets, not just oil and gas.

10:27Sam Fleming: So I suspect you might hear quite a lot about scenarios. In such a scenario, you might see this versus another scenario, you might see that rather than very clear central views on what is going to happen next because no one has any visibility right now.

10:54Myles McCormick: sam and miles i'm curious which economy you're focused on as being the most vulnerable to this

11:01Sam Fleming: whole thing i'll defer to miles on on the u.s which i would say is possibly one of the less vulnerable economies to this given its exporter of natural gas and oil but miles will have his views on that. My sense is that the Asian economies, you've seen obviously South Korea's stock market reacting very strongly, are pretty exposed to this. China has enormous stockpiles, so perhaps less exposed than some other Asian economies. But Europe is very badly exposed to this. Italy, for example, big natural gas importer, very exposed to a natural gas price shock as well as an oil shock. The UK is an interesting one as well.

11:38Sam Fleming: If you look at some of the forecasts we've seen, for example, from Oxford Economics, they're looking at an upward inflection in terms of inflation in the Eurozone and the UK, which is twice as big as the upward movement they expect from this energy price shock from within the US and Canada. And the UK is a good example of this, because broadly speaking, it's a very big importer of gas. Gas plays a very important role in setting the marginal price of power. So it has strong ripple effects into the energy sector and power generation as well as into the prices at the pump. And this was a delicate time for the UK in terms of inflation, because inflation is still relatively high in the UK.

12:20Sam Fleming: It's come down a fair way, but it's still comfortably above the Bank of England's target. And so the view was that the bank ought to be able to cut interest rates next week. That very much is off the table now because of this crisis. And so it's a good example of an economy which is really directly and very strongly affected by this energy shock.

12:40Myles McCormick: What does that do, just out of curiosity, to investors, consumers, that the global economy was headed one way, you know, disinflationary direction, and now could be headed another way with higher interest rates again, right? That's got to give somebody some whiplash.

12:58Sam Fleming: Yeah, I mean, I think it does. I think we shouldn't jump too far ahead of things. I know the markets are beginning to tentatively price increases in official interest rates. I don't I think we're quite there yet. I think more likely the short-term response will be just a lot more cautiousness. But yeah, this is a massive reversal in where we were in terms of the central bank story. The story was they declared victory pretty much over the post-pandemic, post-Russia invasion, inflationary spiral. They'd learned their lessons. Inflation was on the way down. They were easing policy. There was a bit for, maybe not for the ECB, but certainly other central banks like the Fed and the Bank of England, there was room for further rate reductions.

13:38Sam Fleming: And this was a relatively benign picture after a pretty torrid time on inflation and monetary policy. And that picture has been completely turned on its head.

13:47Myles McCormick: Just to jump in there briefly, if I could, on the kind of US side of things in terms of how exposed this country is. I mean, as Sam mentioned, because of the US's role as this massive energy exporter, I mean, over the last kind of 15, 20 years as a result of the Shell Revolution, the US has become not only the biggest producer of oil and gas in the world, but also the biggest exporter of oil and gas in the world, which means that it actually benefits to some degree from higher prices. I mean, certainly it's energy producers and exporting companies do. So a lot of the kind of money transfers that are made will actually be a boost to the US.

14:32Myles McCormick: You'll have these companies making more money as opposed to some countries like Sam outlined there that are big importers of energy and therefore are just throwing money out the door. I would caveat though with the fact that's not much help to you if you are like a motorist looking to go up and fill your tank at the local gas store and sorry, petrol slash gasoline translation again. You're bilingual. Yeah, exactly. But yeah, if you're in a forecourt and prices have gone through the roof and you're trying to fuel up, it's not really much consolation to you to know that big oil and gas majors are going to be doing all right out of it all.

15:16Myles McCormick: So even if the US economy as a whole is less exposed than some of its neighbors and allies might be. Everyday Americans are still very much going to feel the impact of this. There's going to be an inflationary fallout. And yeah, it's kind of the folks on the ground that are going to be squeezed the hardest by it.

15:36Sam Fleming: And I think also there's a global story there as well, right? Because if you're a big oil and gas producer in the Middle East right now, there's major disruption, especially if you're highly reliant on the strait of Hormuz. So although prices have gone up for big oil producing and gas producing countries, they're enormously affected, not least by the war itself, but also because of the disruption to production and shipments. Whereas if you're a producer, say Norway or Canada, which is far away, Brazil, far away from West Africa, far away from the conflict, then there is more of a direct benefit in terms of profits for oil producers in those regions.

16:16Sam Fleming: and less of a disruption or much less of a disruption in terms of actual supply. So there's a benefit there. This doesn't mean there aren't knock-on effects in terms of the fact that the prices of these commodities are spiraling upward everywhere and that hits consumers and also can have a ripple effect into other commodities as well, which can affect consumers, for example, through the feed-through into food prices.

16:38Myles McCormick: We keep talking about consumers, and rightfully so, because these are the people, as we've discussed, who are going to be hit hardest. It reminds me of a few years back, Miles, you might remember this. There were these stickers of Joe Biden at the gas or petrol pump pointing to the price. And it said, I did that. That was a huge part of Trump's campaign when he ran for president in 2024 was affordability. We've got the midterms coming up. Gas prices are going up at this time in the run-up to the midterms. I mean, what options does the Trump administration have if the war starts to hurt Americans' pocketbooks in this crucial political time?

17:20Myles McCormick: Well, I mean, I think this is the crux of it. It's what it all really comes down to. And I remember those stickers as well. I was living in Texas at the time, and they were on the bumper of every car or kind of stuck beside petrol pumps in fuel stations. And it just, yeah, underlines, as you say, the political ramifications of this. There's, I mean, no real surer way to lose an election than to have prices at the pump spiraling in the run up to it. So it's a big liability for the Trump administration as it approaches November's midterm elections, which, I mean, just as an aside, makes it all the more astounding that they went ahead and did this.

17:59Myles McCormick: I mean, there was presumably some degree of miscalculation that they didn't think stuff would get this bad. But it's such an own goal for the Trump administration, not least because despite the inflationary pressures that the US has had over the last while, I mean, you mentioned how affordability was becoming a challenge for Donald Trump. Prices at the pump were the one thing he could always point to and say, remember how bad this was under Biden? Look how low they are now. And it was like, yeah, a big kind of economic win without getting into the details of whether he was in fact responsible for it.

18:37Myles McCormick: And now that one kind of big economic win or big inflationary win that he had, he has willingly just thrown it out the window. It's a massive own goal. But sorry, I went off track. You asked kind of what they can do to deal with this. Yeah, yeah, yeah. Is there anything that they can do or is this just something that's completely out of their grasp. No, I mean, there are some bits and pieces. So there was this massive release of oil reserves this week by the US and a lot of its allies, like 400 million barrels more than any other time in history. That's had some effects. I mean, prices, as soon as news broke that this was on the cards, prices were tempered a bit, but they've since been climbing again.

19:21Myles McCormick: Because even with that volume of oil, it kind of only trickles out into the market. And if the closure of the Strait of Hormuz is shutting off about 20 million barrels of oil a day, it's hard to offset that by feeding stocks into the market at a much slower rate. But that's one big lever they have to pull, but perhaps the biggest. Other stuff, more marginal. I mean, one thing they have done or put on the table is the president has said the US Navy can help commercial vessels kind of transit through the strait. But if you're transiting through the strait and Iran is literally launching strikes on boats, having a US naval escort doesn't actually kind of remove the actual threat of you being struck.

20:08Myles McCormick: But from everyone that I've spoken to, the only real way that you'll get prices back under control is resolving this thing. It's bringing Iran to the table and stopping the strikes on boats and reopening the Strait of Hormuz. Everything else is going to be incremental. Guys, at the risk of repeating ourselves, I just want to know before we sign off, what are each of you looking out for in the global economy as this war continues to unfold?

20:36Sam Fleming: Sure. So it's too soon for this to have started showing up in official data or indeed survey data, but it will start appearing in survey data. So how is this affecting business sentiment around the world, confidence, inflation expectations, and particularly pricing intentions among businesses around the world? Are they starting to tell some of the surveys, for example, the PMI surveys, that they're seeing increases in the input prices they pay? And then are they responding by pushing up prices? Are you starting to see any anecdotal evidence that inflation expectations in consumer surveys are beginning to move as well.

21:17Sam Fleming: It wouldn't be surprising to see an increase in short-term inflation expectations in terms of households. They tend to track pretty closely what is happening in the headlines. But if you started to see upward movement in longer-term inflation expectations, that's the sort of thing that central bankers would get pretty nervous about. And do you start to see any of this begin to play out in wage bargaining, you're starting to see the fact that commodity prices are surging, begin to factor into those discussions, which again would give pause for central bankers as they try and assess whether there's a risk of what they call second round effect.

21:55Sam Fleming: So not only the effect of the primary movement in the commodity price on price indices on inflation, but also the risk of this and feeds through into second round effects whereby companies begin to raise their prices as a result, and also workers claim higher wages as a result in order to compensate themselves for rising commodity prices. It's very early days, so we don't have that evidence at the moment, but I think it's certainly something that we and the central bankers will be watching very closely.

22:26Myles McCormick: The thing I suppose I'll be watching most closely is just what happens to the price of petrol. It just strikes me in an election year that this could have such big ramifications politically for Donald Trump and for his Republican Party in these midterms if prices continue to escalate. And we've been speaking to folks in recent days, doing some reportings, and they're already angry. And polling shows that people are pinning the blame on Donald Trump. so that's what I'll be watching and I think it could like not to do too much crystal ball gazing but I mean if it gets too bad it could be the kind of defining decision of Donald Trump's presidency Alright guys I want to wrap up here I want to thank you both Miles McCormick he's the FT's US economics correspondent thanks Miles Thanks Mark and Sam Fleming the FT's economics editor thanks Sam Thanks Mark

23:35Myles McCormick: This is Swamp Notes, the U.S. politics show from the FT. If you want to sign up for the Swamp Notes newsletter, we've got a link to that in the show notes. Our show was produced by Henry Larson. It was mixed by Sam Giovinco. We had help this week from Lauren Fedor. Special thanks to Pierre Nicholson. I'm your host, Mark Filippino. Our executive producer is Topher Forges. The FT's global head of audio is Cheryl Brumley. And original music by Hannes Brown. Check back next week for more U.S. political analysis from the Financial Times.