Breaking news! The clouds of war reignite, oil prices surge by 9%, and the door for the Federal Reserve to cut interest rates is closing. How is your $BTC doing?

The fire in the Middle East has once again shifted the global capital’s focus back to inflation, the old adversary. The US and Israel’s strikes on Iran have directly pushed up international oil prices, making the recently eased US inflation pressures uncertain again. If the oil shock develops into a prolonged conflict, the path to inflation decline could be blocked, and the Federal Reserve’s limited room to cut interest rates will be further squeezed.

Recently, Brent crude oil prices hit $85 per barrel for the first time since July last year, with an intraday increase of up to 9%. Futures prices for diesel and gasoline also rose in tandem. Previously, US consumers could rely on relatively cheap gasoline to offset high costs like food, but now, this small buffer is being quickly eroded.

Looking back at January data, the US CPI rose 2.4% year-over-year, cooling from 2.7% in December, partly thanks to a 7.5% YoY drop in gasoline prices. However, if crude oil prices continue to rise, gas station prices could respond within weeks and further transmit to transportation and airline ticket costs, expanding the impact on overall prices. Economists estimate that if oil prices stay high for an extended period, reaching $100 per barrel, overall inflation could increase by about 0.7 percentage points.

The core issue for markets is the “intensity and duration” of the shock. JPMorgan’s CEO recently said that as long as military actions are not prolonged, their impact on inflation won’t be significant. However, former President Trump’s comments have introduced another expectation, suggesting the conflict could last four to five weeks and hinting at the possibility of extension. This uncertainty is exactly what markets fear most.

Market concerns are already reflected in rate expectations. Traders now see about a 50% chance of the Fed making a second 25 basis point rate cut this year, down sharply from “possibly twice” last Friday. This sharp reversal has driven US short-term Treasury prices down, with the two-year yield jumping 12 basis points to 3.59%.

The transmission chain from oil prices to inflation is quite clear. Gasoline prices are highly correlated with inflation indicators because their transmission path is short, prices update frequently, and market competition is intense. The main factor determining US gas station prices is crude oil costs. A rule of thumb is that a 5% increase in oil prices can raise YoY inflation by about 0.1 percentage points. While seemingly small, the cumulative effect over time is significant.

More importantly, there are spillover effects. Rising oil prices push up trucking costs, which in turn affect food and other goods prices; higher aviation fuel costs directly increase airline ticket prices. This means energy shocks can quickly expand their impact.

Currently, economists mainly consider two scenarios. If energy market disruptions are short-lived—like last year’s 12-day conflict between Iran and Israel, which only temporarily pushed oil prices up by about $10 without damaging infrastructure—the inflation impact might last only a month or two. Moreover, gasoline accounts for only about 3% of total consumer spending, far below food at 13% and over a third of housing costs. Therefore, unless oil prices surge significantly and persistently, gasoline alone is unlikely to dominate inflation trends long-term.

However, more severe scenarios must be considered. Harvard Business School economist Alberto Cavallo points out that if the conflict causes sustained increases in oil prices, the impact could be reflected at gas stations within weeks, raising overall inflation. As mentioned, maintaining oil prices at $100 per barrel over the long term could add nearly 0.7 percentage points to inflation.

What does this mean for the Fed? In scenarios where inflation is likely to rise, Fed officials will find it harder to “ignore” the upward risks from energy prices. Some analysts suggest that if inflation is significantly driven higher by oil prices, the Fed will be “less willing” to cut short-term interest rates. The current monetary policy environment is not only influenced by energy. Since the beginning of the year, amid a stable labor market and persistent core price pressures, the case for further easing has weakened. If potential energy shocks are combined with the lagging effects of previous tariff hikes still passing through the price chain, the Fed will likely be more cautious about starting rate cuts.

Although the Fed has historically viewed energy shocks as short-term disturbances and preferred to “ride it out” rather than react immediately, the key premise for the three rate cuts from September to December last year was clear signs of short-term inflation improvement. Now, if oil prices push inflation higher again, it will raise the bar for further rate cuts. Markets are responding by sharply reducing expectations for rate cuts, with US Treasuries falling, pointing toward a more tightening financial environment. For highly liquidity-sensitive cryptocurrencies like $BTC and $ETH, this is definitely not good news.

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