Higher Oil Prices Complicate Monetary Policy

by Eugenio J. Alemán of Raymond James, 6/18/25

If there is something the Federal Reserve (Fed) does not want to see today, as it approaches next week’s Federal Open Market Committee (FOMC) meeting, it is a shock to oil prices. The reason for this is that it brings back memories of the 1970s and 1980s, when oil prices surged and contributed to higher inflation during those decades. But the similarities don’t end there. Some of the actors of the events that triggered the shocks to oil prices are also familiar and involve Israel and Iran.

However, we have come a long way from the 1970s and the 1980s, especially when it comes to the consumption of petroleum. The global economy does not depend as much on oil today as it did back in the 70s and 80s, and thus, a petroleum shock is not as impactful as it was during those decades. Of course, the total impact on petroleum prices is difficult to predict because it will depend on the evolution of the conflict between these two countries.

But the truth is that one of the most important contributors to lower inflation over the last year or so has been a decline in petroleum prices, and the current conflict will probably disrupt this trend. Thus, there is a high probability that Fed officials will be spooked and their risk aversion will increase, which means that monetary policy will probably remain restrictive for a longer period of time. That is, tariff as well as petroleum price uncertainty will definitely keep the Fed on the sidelines for next week’s meeting and could potentially reduce the probability that they will lower interest rates later in the year.

Under this scenario, the core PCE price index and the core CPI price index will be of utmost importance for the Fed. If headline inflation accelerates but core inflation remains contained, then the monetary policy path could remain intact. However, if we see both headline and core inflation moving up, then the prospects for lower interest rates are probably less likely.