Central Banks Struggle as Oil Surges and Geopolitical Tensions Rise

The Federal Reserve and the European Central Bank are grappling with unprecedented challenges as oil prices surge and geopolitical tensions escalate, particularly with the United States' potential military involvement in Iran. The White House has indicated that President Trump will decide on Iran action within the next two weeks, adding to the uncertainty. ECB officials have expressed concerns about the Euro's global role, with traders awaiting key economic data from Germany and the United States.

The surge in oil prices, driven by geopolitical risks and potential disruptions in energy flows through the Strait of Hormuz, poses a significant threat to global economic stability. Any disruption in this critical chokepoint, through which roughly 20% of global energy products pass, could lead to a spike in oil prices, increased inflation, and pressure on central banks. This situation is further complicated by the haphazard threats of heavy trade tariffs from President Trump, which have left top central banks trying to steer policy amidst elevated uncertainty about economic growth and inflation.

The Federal Reserve, which kept interest rates unchanged at 4.25%–4.50% on Wednesday, has struck a cautious tone. Chair Jerome Powell emphasized a data-dependent approach, noting risks related to inflation and tariffs. While Fed projections signal two cuts by year-end, the cautious commentary suggests that monetary policy might remain tighter than anticipated. This has led to a temporary stall in the US Dollar's strength, as markets balance the Fed's data-dependent stance with rising geopolitical risks.

The escalating Israel-Iran conflict has further fueled geopolitical tensions. Russia has issued a stark warning against potential US military involvement in Iran, describing it as an "extremely dangerous step" with "unpredictable negative consequences." Israeli Defense Minister Israel Katz has emphasized the need for intensified attacks following recent escalations, underscoring ongoing risks tied to the Israel-Iran conflict. President Trump is scheduled to hold a second Situation Room meeting this week to evaluate potential US involvement in the Middle East crisis, raising stakes over potential preemptive action.

This came to a head on Thursday after Norway cut interest rates without warning. The decision shocked traders and pushed the Norwegian crown down about 1% against both the dollar and the euro. At the same time, Switzerland cut its rates to 0%, scrapping talk of returning to negative rates despite persistent deflation. The Swiss central bank said the global outlook was too unstable to follow normal plans. Just 24 hours earlier, Fed Chair Jerome Powell kept US rates unchanged and told reporters that “no one” has confidence in where rates should go.

Investors immediately pulled out of stocks. European equity volatility jumped to a two-month high. But instead of buying government bonds as a safe bet, they sold those too. Traders saw no clear direction. Even the usual havens are failing. “We’re at a moment of considerable policy and macro uncertainty,” said Mark Dowding, chief investment officer at RBC Global Asset Management’s BlueBay. “We can’t see a clear trend on interest rates.” He admitted he was holding off on making major moves across his firm’s portfolios.

The dollar is now a wildcard. Its value has dropped almost 9% this year against other major currencies. But that changed after military conflict broke out between Israel and Iran, sending the dollar rising again. Every movement now is driven by war headlines and energy shocks, not central bank guidance. “You cannot just take your cues from the central banks anymore,” said Davide Oneglia, director of macro at T.S. Lombard. He said the banks are struggling just to read the data, let alone give direction.

European central banks cutting rates are not just moving differently from the Fed, which is still wrestling with rising prices caused by Trump’s tariffs. They’re also dealing with a volatile dollar, which used to anchor global trade and commodity prices. That’s no longer working. “That’s a massive, massive fundamental shift in global markets that everyone is trying to assess,” said Nick Rees, head of macro research at Monex Europe. “All of those standard economic rules of thumb we use for forecasting are completely broken right now.”

At the European Central Bank, even planned rate cuts are under review. Francois Villeroy de Galhau, a key ECB policymaker, said on Thursday that if oil volatility keeps going, they might have to change course. That puts the entire monetary plan in doubt. The big picture is simple: central banks can’t lead when the ground keeps moving. Analysts said the new market environment is shaped by surprise events, not policies. With every escalation involving Iran, the chance of sudden pricing changes grows. Investors have to brace for that.

“We’re getting into this next cycle in which variables are much more volatile, because, rather than (monetary policy) being just easily predictable, events just take over and policy and human factors, as we now know with Donald Trump, play an important role,” Oneglia said. Every piece of this matters. Currency values have shifted dramatically in just a few months. Models don’t work. Central banks can’t promise anything. Trump is making the biggest decisions from the White House, and Iran is the wild card no one can price in.