Three Wars, Three Economies
We have argued since the opening days of Operation Epic Fury that the economic consequences of the Iran war depend less on the price of oil this week than on one question: how long does this last? The Strait of Hormuz is the line between a scare and a shock, and the shock’s severity scales with duration. Wall Street is now running the numbers on that framework, and the estimates are worth examining.
Bank of America’s research team has mapped three distinct economic scenarios, and the results cut against the market’s reflexive assumption that oil shock equals inflation equals Fed tightening. That assumption is wrong in at least two of the three cases — and dangerously wrong if the Fed itself takes it seriously.
The Short War
If the conflict resolves quickly — Hormuz reopens and the global oil supply returns to pre-war levels — the damage is minimal. Bank of America estimates roughly 15 basis points of additional PCE inflation over the course of a year and about 15 basis points off growth. Those are rounding errors. Brent crude would likely average around $70 a barrel for 2026, according to Bank of America’s estimate. In this scenario, the Fed is basically frozen in a wait-and-see pattern. Most Americans would barely notice beyond the temporary pain at the pump they have already experienced.
The Medium War
If the conflict drags into the spring, the calculus changes. Bank of America expects 2026 growth to come in between two percent and 2.5 percent, down from a prior forecast of 2.8 percent, with headline and core PCE inflation ending the year around three percent and oil averages closer to $85.
The inflation here is real, but its sources matter. Direct energy costs push up gasoline and utilities. The Hormuz closure, which is blocking roughly 20 percent of global LNG supply, puts upward pressure on natural gas across Europe and Asia with knock-on effects on electricity costs. And the effect on fertilizer is under appreciated. Gulf states account for 34 percent of global urea exports and 23 percent of ammonia, most of it transiting Hormuz. This will not be a “pass-through” story in which farmers simply get to pass on their higher costs. Instead, the most likely outcome is a supply crunch that will show itself in grain yields six to 12 months later, when Northern Hemisphere crops come in light.
This is also the scenario where the Fed is most paralyzed and, therefore, most dangerous. Inflation is uncomfortably high, but growth is tepid rather than collapsing. There’s no clean move. Bank of America expects the Fed to stay frozen unless unemployment starts trending toward five percent. But, as we argued on day one of this conflict, the Fed’s credibility scar from the transitory inflation debacle creates asymmetric temptation: it is far easier for the Fed to demonstrate toughness by leaning hawkish into a headline shock than to explain why doing less is the economically correct response when gasoline prices are rising and the inflation headlines are screaming.
This risk is amplified by the Fed’s antagonism toward President Trump and his administration. Former New York Fed President William Dudley argued back in 2019 that the Fed “shouldn’t enable” Trump’s tariff policy — that it should allow short-term damage to the economy in the name of crushing bad trade policy and hurting Trump’s reelection chances. Dudley wasn’t alone. Many prominent economists have called for similar approaches, if not quite as explicitly. While few current Fed officials would publicly sign on to this view, it is likely operating in the background of their thinking. Why should they support “Trump’s war” in Iran? Allowing some damage now would worsen the GOP’s chances of holding the Senate or the House in the midterm elections, stemming Trump’s power to enact his policies.
This would be a policy mistake. The Fed’s hawkishness and its resistance to the administration’s policies would run the risk of manufacturing a recession. But just because something is stupid does not mean the Fed will not do it.
The Long War
The longer war quagmire scenario is where conventional wisdom breaks down entirely. A conflict that stretches into the second half of the year does not produce a stagflationary spiral. It produces a contraction or even a recession — even without a Fed mistake — and recessions are deflationary.
The mechanism is straightforward. Sustained oil above $100 destroys demand. Higher-income consumers pull back when equities correct. Lower-income consumers, already strained by energy costs, see delinquencies rise and credit access tighten. Bank of America estimates GDP growth falls to around one percent in this scenario, with more severe variants flirting with outright contraction. At that point, the inflation from energy and food is temporary. What’s durable is the demand collapse. Bank of America notes that when oil has fallen 50 percent, the Fed has cut rates an average of 154 basis points over the subsequent six months. Even 100 basis points of cuts in a single year would be on the table.
The Hidden Risk in All Three
What Bank of America’s scenario analysis doesn’t fully reckon with is a risk that cuts across all three scenarios. Ben Bernanke — back when he was a Princeton professor rather than a central banker — co-authored research suggesting that much of what looks like “oil-shock recession” in the historical record is actually “policy reaction recession.” The Fed sees headline prices moving, over-tightens, and pushes the economy into a slump that the oil shock alone would not have caused.
The conditions for looking through the spike are actually favorable right now. The 5-year/5-year forward breakeven inflation rate is sitting near the low end of its historical range — exactly the anchored-expectations environment that Bernanke identified as giving the Fed room to be patient. Iranian missiles and higher oil prices won’t tank the U.S. economy on their own.
But a monetary policy mistake can shorten the distance between a scare and a shock considerably — and that risk exists in every scenario on the board.
