Market Update: The Fed is no stranger to oil crises. But this time could be different – Full Analysis

Washington
 — 

The worst global oil crisis in decades could become a major problem for the Federal Reserve, whose policymakers meet this week to determine the next moves for the US economy.

President Donald Trump’s war on Iran has sent oil prices skyrocketing, with WTI, the US crude benchmark, briefly reaching $120 last week, threatening to raise the cost of almost everything Americans buy. At the same time, those higher energy costs could squeeze businesses and households, slowing hiring and stalling economic growth.

That twin threat of higher inflation and a weakening job market is thrusting Fed officials into a lose-lose scenario just as Kevin Warsh, Trump’s pick to lead the central bank, awaits Senate confirmation — at a highly inopportune time for any official to be arguing for lower interest rates.

The Fed hasn’t confronted an oil shock this severe since the 1973 Arab-Israeli War, which triggered the notorious stagflation episode of that decade. But America’s economy looks a lot different today and its central bank is unlikely to respond the way policymakers did half a century ago, when aggressive rate hikes pushed the economy into recession.

As the world’s largest oil-producing country, the United States is much less reliant on imported crude than it was during past energy crises. But the disruption to global energy markets this time around is greater, experts say.

“The total amount of Gulf oil production that’s currently locked up due to this war is much bigger than it was back then,” Nicholas Mulder, a history professor at Cornell University who researches the economic impacts of wars, told CNN. “We’re talking about 20 million barrels versus about four and a half million in 1973… so this is really several times larger.”

In October 1973, Egypt and Syria carried out a surprise attack on Israel in a conflict that quickly escalated and eventually drew in the United States.

The Arab members of the Organization of Petroleum Exporting Countries cut off oil to Western nations in retaliation. That inflicted significant pain on the US economy, which was heavily dependent on foreign oil at the time. Under then-Fed Chair Arthur Burns, policymakers resisted raising interest rates, arguing that the various factors pushing up inflation at the time — including the oil shock — were largely outside the reach of monetary policy. While the Fed did eventually raise rates, it did so intermittently. Economists now say it was that “stop and go” approach that allowed inflation to become entrenched and did little to shore up growth.

One economist captured that sentiment in a presentation delivered at one of the Fed’s rate-setting meetings at the time: “The question is whether monetary policy could or should do anything to combat a persisting residual rate of inflation … The answer, I think, is negative. … It seems to me that we should regard continuing cost increases as a structural problem not amenable to macro-economic measures.”

But now, America is the world’s top oil producer and it has a services-based economy, meaning it’s less vulnerable to global oil production cuts. And Fed officials, learning from Burns’ missteps, now broadly believe that monetary policy does play an important role in managing economic shocks.

However, “We’re in a situation today where facilities are under attack from Iranian drones and missiles,” said Josh Freed, senior vice president for the climate and energy program at Third Way. “That’s physical damage that could take a while to repair, so this makes it potentially worse than the oil embargo of the 1970s. There’s just a ton of uncertainty around all this.”

Already, Americans are feeling the pinch at the pump and the war has started to weigh on people’s expectations of where inflation is headed: The University of Michigan’s latest consumer survey, released Friday, showed that sentiment declined 2% this month from February, with consumers increasingly citing the war in their responses.

There isn’t much wiggle room on the job front, either. The Bureau of Labor Statistics earlier this month reported that employers shed 92,000 positions in February as the unemployment rate rose to 4.4% from 4.3%. A separate report Friday showed that job openings rose by 400,000 in January from December, though there are still more unemployed people seeking work than there are openings.

“There’s very little question that there is going to be an inflation effect” from the war with Iran, said Tani Fukui, senior director of economic and market strategy at MetLife Investment Management. “But how big it will be is still very much an open question.”

The question for Americans during this oil crisis is not just how high prices will go, but whether the Fed can rely on history’s lessons to keep the economy from tumbling.