Last weekend, the US and Israel attacked Iran, aiming to eliminate the threat posed by Tehran's nuclear and missile programs to the national security of the world's largest economy. The conflict has extended into its 4th day, spreading across several Middle Eastern countries.

The conflict caused world crude oil prices on 2/3 to temporarily rise from 70 USD to nearly 80 USD a barrel, before cooling down slightly. Meanwhile, shipping activity through the vital waterway, the Strait of Hormuz, was almost paralyzed.

The US is less affected by energy shocks than other developed nations, thanks to its large oil and gas production. However, the conflict could still impact trade, prices, and investment, weakening the growth outlook emerging this year.

President Donald Trump delivers the State of the Union address to the US Congress on 24/2. AP.

A recent survey by the Conference Board consulting organization shows a strong increase in CEO confidence regarding the US economic outlook and their respective sectors. However, nearly 60% believe the risk of geopolitical tensions causing economic disruption is currently very high.

In its latest report, the World Bank (WB) assessed the US economic outlook as "bright", but this scenario is threatened by conflict in the world's key oil-producing region. The conflict will have numerous consequences for maritime transport, supply chains, and global commodity prices.

Last year, the US economy grew by 2,2%, its slowest rate in three years. Joseph Lupton, an economist at JPMorgan, stated last weekend after US airstrikes on Iran: "Early year data indicates businesses have begun to move past hiring freezes and capital expenditure. However, military conflict, along with trade instability, could raise concerns about US economic recovery and global stability".

The impact on the US economy and the monetary policy of the Federal Reserve (Fed) also depends on the pace of oil price increases and the risk of escalating conflict. "The conflict with Iran is an unpredictable variable", analysts at SGH Macro Advisors stated.

Similarly, lessons from the 2022 Russia-Ukraine conflict present similar risks to the US economy. The Fed's initial response was accommodative, with officials scaling back plans for aggressive interest rate hikes. However, their concerns quickly shifted back to inflation, accelerating the rate-hiking cycle.

Nevertheless, the initial impact of the current Middle East tensions on markets remains contained. Interest rate futures lean slightly towards a potential Fed tightening, but still maintain expectations for the agency to adjust interest rates two times this year, starting in July.

US two-year Treasury yields declined last weekend. This is a common reaction during volatile periods as investors seek safe-haven assets. However, yields rose sharply again in early week trading, reflecting inflation concerns and increased risk. The US dollar, another safe-haven asset, gained against a basket of major currencies in early week trading. Major US stock indices showed little change.

Analysts at Citi stated: "We do not believe geopolitical developments will significantly impact the Fed's interest rate plans. Inflation risks are offset by domestic data. The economy is projected to add 55.000 jobs in February, with the unemployment rate around 4,4%. This level is sufficient for the Fed to believe the labor market is stabilizing".

Meanwhile, at an S&P Global conference on 2/3, former Fed Chair Janet Yellen suggested the conflict risks pushing US inflation higher and slowing growth. This "makes the Fed even more cautious, hesitant to cut interest rates".

The world is closely watching the unpredictable developments of the Middle East conflict. Christopher Hodge, chief US economist at Natixis CIB Americas, commented: "Risks are increasing significantly". He outlined several scenarios, from an early resolution of the conflict and a new government in Iran, to a prolonged tension that could disrupt global supply chains.

Hodge analyzed that if Iran's retaliation is insignificant, the impact on oil prices would quickly diminish, causing only a relatively minor economic effect. In such a scenario, the Fed's interest rate policy would remain largely unchanged.

Conversely, if the conflict spreads throughout the region, creating ripple effects on global trade routes and supply chains beyond the energy sector, oil prices would remain above 120 USD a barrel, a 50% increase from current levels. At this point, the shock would no longer be limited to the energy sector. Vital shipping lanes would be disrupted, insurance costs would surge, and the global production network would be affected. The consequence is that the US could experience negative growth, rising unemployment, a large budget deficit, and the Fed would have to quickly cut interest rates to prevent a recession.

Ha Thu (according to Reuters, Bloomberg)