The escalation of the Israel-Hamas war increases inflation risks, and The Federal Reserve (FED) is closely monitoring the situation.

Author: Nicole Goodkind(；Compiled by: Barrons The escalation of the Middle East situation is driving the oil market and inflation expectations to rise, making it more challenging for The Federal Reserve (FED) to balance its two main objectives of price stability and full employment, especially as officials prepare for next week's meeting.

The uncertainty of tariffs has caused The Federal Reserve (FED) decision-makers to adopt a wait-and-see approach to interest rate decisions, and the current volatility in the oil market is likely to make them even more cautious.

After Israel launched military operations against Iran's nuclear facilities and military targets, crude oil prices soared, and Iran subsequently initiated drone and missile counterattacks, raising concerns about further conflicts. Oil prices initially rose by more than 13% after the news broke, although they later retreated, analysts believe that oil prices may remain elevated for some time.

"The rise of geopolitical uncertainty means that the energy market must factor in a higher risk premium for potential supply disruptions," analysts at ING Group wrote in a report on Friday. They warned that if shipping through the Strait of Hormuz, which is the chokepoint for nearly one-third of global oil trade, is disrupted, Brent crude prices could surge to $120 a barrel. Currently, Brent crude is slightly below $75 a barrel.

Even in relatively mild scenarios, the rise in energy prices could cause inflation rates to remain high for a longer period and force the Federal Reserve (FED) to continue maintaining high interest rate levels. ING analysts wrote, "The surge in oil prices has the potential to disrupt the current narrative regarding inflation in the United States — even though the U.S. has imposed tariffs, inflation performance has consistently been more moderate than expected." They indicated that although inflation in commodity prices is relatively stable at the moment, "we expect to see larger increases in monthly inflation data throughout the summer."

These concerns have already been reflected in the market's volatility. "If this situation is not resolved quickly, it will definitely have some impact on inflation data," wrote Louis Navellier, founder of Navellier & Associates, on Friday. He stated that the bond market "seems to be reacting more to the threat of inflation rather than the possibility of World War III."

On Friday, both the 2-year and 10-year U.S. Treasury yields rose.

The surge in energy costs could lead investors and the public to raise their expectations for short-term inflation, creating a potentially self-reinforcing dynamic that might force The Federal Reserve (FED) to take action.

RSM Chief Economist Joe Brusuelas ) Joe Brusuelas ( wrote in a report: "The main risk to the interest rate outlook is that inflation expectations lose their anchor. If consumers push up short-term inflation expectations, then the Federal Reserve (FED) will almost certainly delay any thoughts of rate cuts until at least December, or even into next year."

Federal Reserve officials expect to maintain interest rates unchanged throughout the summer. The latest geopolitical developments may further reinforce this view. However, Brusuelas warns that the combination of "tariffs and price shocks caused by oil" could prompt a shift in policy, leading the Federal Reserve to delay interest rate cuts even further or even raise rates.

Currently, the Federal Reserve (FED) seems more inclined to stay put and observe the situation. Brusuelas stated, "Given the new tariffs and rising energy prices, the Federal Reserve (FED) should temporarily hold off on any action until the current volatility passes."

According to the CME FedWatch tool, the market currently expects two rate cuts by the end of 2025, totaling a decrease of 0.5 percentage points.

The Federal Reserve (FED) will hold its next meeting from June 17 to 18, and the market widely expects this to be the fourth consecutive time that interest rates will remain unchanged.