The ongoing conflict involving Iran has triggered a severe oil supply shock, with flows through the Strait of Hormuz remaining approximately 18 million barrels per day (b/d) below pre-war levels, representing a -98% reduction compared to pre-war volumes [5]. Gulf producers have cut production by over 10 million b/d, and this figure may continue to rise, resulting in at least 200 million barrels of Middle East oil not produced by the end of the month and a weekly loss of 70 million barrels [5]. Floating storage outside the Middle East has declined by as much as 35% or 33 million barrels since the conflict began, and Asian excess floating inventory above the 5-year average has been completely eroded [5]. The International Energy Agency (IEA) Strategic Petroleum Reserve (SPR) release flow rate is estimated at nearly 3 million b/d, which is insufficient to offset the supply loss, and the US SPR release saw only 45.2 million out of 86 million barrels awarded, with limited demand due to exchange and basis risk [5]. Unless a deal leads to a swift reopening of Hormuz, benchmark oil prices are expected to move sharply higher [5].
The geopolitical uncertainty is also impacting currency and central bank policy. The Euro (EUR) is under pressure against the US Dollar (USD), with EUR/USD trading around 1.1585, down about 0.20% on the day, and the US Dollar Index (DXY) at 99.40 after an intraday low of 99.07 [2]. Iran has signaled unwillingness to accept US-led ceasefire proposals, insisting on its own terms for ending the conflict, including guarantees, compensation, and recognition of its control over the Strait of Hormuz [2]. The US proposal reportedly includes a 15-point plan with a one-month ceasefire, curbs on Iran’s nuclear program, and guarantees to keep Hormuz open in exchange for potential sanctions relief [2]. Mixed signals from both sides suggest a meaningful breakthrough is unlikely in the near term, raising the risk of prolonged conflict and oil-driven inflation concerns [2].
Central banks are responding to the energy shock with caution. The Federal Reserve (Fed) faces conflicting signals and is expected to remain in a holding pattern in the near term, with rate cuts penciled in for later in 2026 if conditions allow [1]. TD Securities strategists note that the Fed will look through the energy shock as long as inflation expectations remain stable and second-round effects on core inflation are contained [1]. Compared to 2022, the US economy is less vulnerable, allowing the Fed to be more attentive to downside risks [1]. Meanwhile, market expectations for Fed rate cuts this year have been largely priced out, with anticipation that the Fed will hold rates through 2026 [2].
The European Central Bank (ECB) is likely to respond to renewed energy shock with additional tightening, focusing on preventing second-round inflation effects [4]. ABN AMRO economists expect two ECB rate hikes over the coming months as wage growth normalizes near the 2% target [4]. ECB President Christine Lagarde emphasized the need for sufficient information before acting and warned against non-targeted fiscal support, urging governments to adopt measures that are Temporary, Targeted, and Tailored [2][4]. A Reuters poll showed that 38 out of 60 economists expect the ECB to keep its deposit rate at 2.00% this year, while 21 see at least one rate hike in 2026 [2].
Market sentiment remains cautious, with global stocks and bonds rallying and Brent crude oil prices trading near $100 a barrel [3]. Brown Brothers Harriman (BBH) notes that while global risk sentiment has improved as markets position for potential conflict resolution, USD risks remain skewed to the upside due to dollar funding needs in periods of financial stress [3]. BBH maintains a cyclically neutral USD view within a 96.00–100.00 DXY range but is structurally bearish longer term due to fading confidence in US trade and security policy, worsening fiscal credibility, and politicization of the Fed [3].
CONCLUSION
The deepening oil supply shock and persistent geopolitical tensions are driving inflation concerns and complicating central bank policy, with both the Fed and ECB expected to maintain or tighten rates in the near term. Unless a swift resolution is reached, oil prices are likely to rise further, sustaining market volatility and risk aversion. The situation remains fluid, and central banks are prioritizing inflation containment and cautious policy responses.