“High Oil Prices and Tariffs Drive Inflation Higher”: U.S. Squeezed by Supply-Side Inflation as September Fed Rate Hike Becomes All but Certain

War-Driven Risks Send Global Oil Prices Soaring, Driving Up Corporate Production Costs
“We Have Yet to Fully Raise Prices”: Fallout From Trump Administration’s Tariffs Persists
September Rate Hike Now the Dominant Forecast, With Further Tightening Also Possible

U.S. companies are struggling to set product prices. Persistently high oil prices stemming from geopolitical risks in the Middle East, compounded by the burden of the Donald Trump administration’s tariff policies, have built up upward pressure across production costs. As the risk of supply-side inflation intensifies by the day, markets are increasingly embracing the prospect that the Federal Reserve’s (Fed) tightening timetable could advance faster than previously expected.

Persistent Disruption Across Energy Supply Chains

On September 16 (all dates local), The Wall Street Journal (WSJ) reported that “U.S. companies are facing significant pricing challenges as it becomes increasingly difficult to predict how long elevated energy costs will persist.” Energy supply-chain shocks arising from geopolitical instability in the Middle East are placing upward pressure on prices. Since the military conflict between the United States and Israel on one side and Iran on the other escalated in February, cargo traffic through the Strait of Hormuz—which had carried approximately 20% of global crude oil and liquefied natural gas (LNG) supplies—has fallen markedly. In effect, the principal export corridor for Middle Eastern oil producers has been blocked. Saudi Arabia, a major oil producer, had used the East-West Pipeline, which carries crude from eastern oil fields to the Red Sea port of Yanbu, as an alternative export route, but even that pipeline recently suspended operations after a drone attack.

Production shutdowns at some Libyan oil fields and Ukrainian attacks on Russian refining facilities have further constrained crude supply capacity outside the Middle East. Against this backdrop, global oil prices have continued their steep ascent. Brent crude, which settled at $72.48 per barrel on February 27, immediately before the outbreak of the Iran war, surged intraday to $82.37 on March 2, shortly after U.S. and Israeli attacks on Iran began. Gains widened further as disruptions to oil production and transportation across the Middle East persisted, and on September 9 Brent crossed back above the $100-per-barrel mark for the first time in approximately seven weeks since July 24. On September 15, Brent closed at $108.75, up 2.9% from the previous session, while West Texas Intermediate (WTI) settled at $105.83, up 4.4%.

Tariff-Driven Inflationary Pressure

The aggressive tariff policies of the second Trump administration are also cited as a key factor compounding inflationary pressures alongside high oil prices. In July, the Federal Reserve Bank of New York published a report on its official blog titled “More Tariff Pass-Through Is in the Pipeline,” arguing that tariffs were raising production costs for U.S. companies. According to the report, approximately 90% of the tariff burden imposed by the Trump administration was passed on to U.S. businesses and consumers rather than foreign producers. Among firms responding to the New York Fed’s survey, two-thirds of service-sector companies and nearly all manufacturers imported raw materials or components required for production; of these firms, 40% of service providers and 70% of manufacturers said they had paid tariffs directly over the past year. Companies that did not pay tariffs directly were also found to have been affected by higher imported-input costs as suppliers raised prices.

Among companies that incurred tariff costs, approximately 30% of service-sector firms and 20% of manufacturers said they had already completed all planned price increases, while 20% of service providers and 30% of manufacturers said they had decided to absorb the tariff costs and had no plans for further price adjustments. By contrast, 47% of service-sector companies and 44% of manufacturers said they intended to raise prices further. In particular, approximately 30% of service providers and 40% of manufacturers planned additional price increases within the next six months, while 16% of service providers and 7% of manufacturers intended to adjust prices in response to tariffs even after six months. “Although more than a year has passed since the tariffs were first introduced, many companies are still adjusting prices,” the New York Fed said. “This is also consistent with recent research finding that tariff pass-through occurs gradually over more than a year rather than all at once.”

Clear Upturn in Inflation Indicators

U.S. inflation indicators are showing a clear upward trend amid these pressures. According to the U.S. Department of Labor, the Consumer Price Index (CPI) rose 0.4% month on month and 3.4% year on year in August. The gasoline index jumped 3.9% in a single month, accounting for more than one-third of the CPI’s overall monthly increase, while energy prices surged 2.1% from the previous month and 16.3% from a year earlier. Gasoline prices rose 27.4% year on year, while heating oil prices climbed 52.0%. Core CPI, which excludes food and energy, increased 0.3% month on month and 2.4% year on year. The Producer Price Index (PPI) for final demand likewise rose 0.4% from the previous month and 5.4% from a year earlier. Producer prices for goods increased 1.1% month on month, while prices for services edged up 0.1%.

The Personal Consumption Expenditures (PCE) Price Index, the Fed’s preferred inflation gauge, also remains elevated. According to the U.S. Department of Commerce’s Bureau of Economic Analysis (BEA), the PCE Price Index rose 3.7% year on year in July, while the core PCE Price Index, which excludes food and energy prices, increased 3.3% over the same period. These readings exceeded the Fed’s longer-run inflation target of 2% by 1.7 percentage points and 1.3 percentage points, respectively. In his Jackson Hole address last month, Fed Chair Kevin Warsh reaffirmed that 2% as measured by the PCE index remains the central bank’s firm inflation target. Fed Governor Christopher Waller also said on September 3 that “July’s PCE inflation rate remains meaningfully above target.”

Table 1. Inflationary Pressures in the United States

U.S. Benchmark Rate Expected to Rise

Against this backdrop, markets are focusing on the pace of the Fed’s benchmark rate increases. According to CME FedWatch, as of the afternoon of September 15, federal funds futures were pricing in an approximately 91.8% probability that the Fed would raise its benchmark rate by 0.25 percentage points at the September 15–16 meeting of the Federal Open Market Committee (FOMC). The implied probability, which had stood at approximately 60% only a week earlier, jumped sharply following the CPI release and the rise in global oil prices. Major Wall Street investment banks are also strengthening their forecasts for a September rate hike. Goldman Sachs recently withdrew its previous call for no change and said it now expects a 0.25-percentage-point increase at this FOMC meeting. Its assessment is that, with rate futures now reflecting sharply elevated expectations for an increase, it would be difficult for the Fed to defy markets and leave rates unchanged. The recent surge in global oil prices was also cited as a factor that could reinforce the hawkish stance of some FOMC members.

JPMorgan, HSBC and Deutsche Bank likewise forecast a 0.25-percentage-point benchmark rate increase at the September FOMC meeting. All three institutions focused on the fact that August CPI and PPI readings came in above expectations, while the worsening situation in the Middle East sent global oil prices soaring and again weakened the disinflationary trend. Morgan Stanley also revised its forecast on September 15 and said it now expects a 0.25-percentage-point increase in September. The bank had previously projected no rate increase this year, but changed course after inflation proved slower to ease than forecast, with August core CPI exceeding its own estimate.

The Monetary Policy Path Ahead

Analysts are increasingly arguing that the rate increase will not be a one-off. According to a recent CNBC survey of 29 Wall Street economists, fund managers, strategists and other industry professionals, 55% of respondents expected the Fed to raise its benchmark rate by 0.25 percentage points at least twice over the next year. One-third of respondents said three or more rate increases could occur within the next year. “No matter where you look in the data, there is no sign that inflation will return to target ‘soon,’” said Neil Dutta, head of economic research at Renaissance Macro Research. “The renewed rise in crude oil, gasoline and diesel prices is intensifying concerns that elevated energy prices could spill over into other goods and services and inflation expectations,” said Kathy Bostjancic, Nationwide’s chief U.S. economist.

Most respondents expected the Strait of Hormuz to remain closed for at least another month and oil prices to stay elevated for more than six months. Approximately three-quarters of respondents also assessed that inflation had become a broad-based economic risk extending beyond energy prices, while some concluded that even Fed rate increases would struggle to contain inflation triggered by high oil prices. “There are limits to controlling supply-side inflation through interest-rate decisions, yet the Federal Open Market Committee (FOMC) faces a formidable challenge because it must demonstrate the institutional credibility of its price-stability mandate,” said Douglas Gordon, a senior portfolio manager at Russell Investments.