The crisis in the Middle East could fuel a flare-up in inflation and hasten an economic slump for the US

People try to extinguish a fire in Ashkelon, Israel, after Hamas launched a series of surprise attacks on October 7.Ahmad Gharabli/AFP via Getty Images

Iran becoming embroiled in the crisis gripping the Middle East could have disastrous knock-on effects for the US economy, analysts have warned.

Wall Street is fretting that Hamas’ shocking attack on Israel Saturday will spiral into a full-blown conflict between Tel Aviv and Tehran that could drive up oil prices, unravel the Federal Reserve’s fight against inflation, and drag down GDP growth.

Here’s what you need to know.

Oil prices could surge

The Brent and West Texas Intermediate crude benchmarks jumped as much as 5% when markets opened Monday, while stocks slipped as investors pivoted to safe haven assets like gold and the dollar in a bid to hedge against heightened geopolitical risk.

Commodity traders were rattled by a Wall Street Journal report Saturday that said Iranian security officials had helped Hamas to plan its shock raid – although both Tehran and the militant group have denied those allegations.

Iran is the world’s seventh-largest oil producer with an average output of around 3.3 million barrels a day, according to government statistics.

Any evidence it was involved in the attack on Israel could encourage the West to impose sanctions that would squeeze already-tight global supply levels and drive prices even higher.

“Reports regarding Iran’s support for the Hamas attack have been denied by Iran but concern is focused on a broader Iran-Israeli conflict, which would, in turn lead to a dramatic escalation of conflict in the region, and a dramatic climb in oil prices,” LPL Financial’s chief global strategist Quincy Krosby said Monday in a research note.

Meanwhile, legendary hedge-fund manager Pierre Andurand wrote in a post on X that the idea that Iran helped Hamas to plot its strikes could lead to the US enforcing sanctions that “would further tighten the oil market”.

“The probability that this will lead to direct conflict with Iran is not zero,” he added.

Inflation might flare up

Over the past 18 months, the Fed has raised interest rates by 525 basis points in a bid to crush US inflation, which has cooled from forty-year highs toward the central bank’s 2% target rate.

But a dramatic rally in oil could spark a flare up, because the price of crude dictates the cost of everyday goods like gasoline.

Developments in the Middle East will pose more of a risk to the US economy “if the conflicts become regional, if Iran becomes involved,” according to CIBC Private Wealth US’s CIO David Donabedian.

“The best measure of whether the conflict has negative staying power will be the price of oil,” he added. That will be the biggest risk that could hurt the economy, corporate profits and inflation.”

Inflation jumping would increase the likelihood that the Fed feels compelled to bring in more rate hikes, with the prospect of higher borrowing costs already weighing on stocks and fueling a historic rout in the US Treasury bond market.

When rates are higher, consumer spending and tends to fall – and so the knock-on effect of Iran being dragged into a conflict in the Middle East could be a slump that hits both the US and the world economy.

“If this expands and brings in other parties, then the outlook is for even a weaker global economy, even more inflationary pressures,” top economist Mohamed El-Erian wanted Monday. “And the markets are going to be finding it hard to deal with that.”

“What’s gonna happen with Ukraine at this point, and Russia? What’s going to happen with China? So this is why the big question for the markets and for the economy is whether you get escalation,” he added.

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