Hormuz and the Fed: How Israel-Iran Conflict Shapes Energy Markets and Monetary Policy

The Israel-Iran conflict has escalated to a level not seen in decades, with direct strikes on nuclear facilities, retaliatory missile barrages, and threats to choke global oil supplies through the Strait of Hormuz. As Brent crude surged to $75/barrel in June 2025—a 20% spike from late 2024—the geopolitical risk premium in energy markets is now front and center. But how does this tension intersect with Federal Reserve policy? History suggests that prolonged conflicts can force central banks to balance inflation risks from energy shocks with the economic drag of supply disruptions.

The Strait of Hormuz: Pivot Point for Energy and Geopolitics
The Strait of Hormuz, through which 20 million barrels of oil flow daily, remains the linchpin of this crisis. Attacks on shipping lanes and Iranian threats to close the strait have already prompted rerouting of vessels and heightened insurance costs. While the strait remains open for now, the risk of a full blockade—though logistically challenging for Iran—looms large.

The conflict's impact on oil prices is immediate. Attacks on Israeli refineries and Iranian infrastructure have already disrupted supply chains, but the real threat lies in a prolonged stalemate. A closure of Hormuz would send prices soaring above $100/barrel, eclipsing even the 2022 post-pandemic peak.

Historical Precedents: Fed's Role in Geopolitical Shocks
To gauge the Fed's likely response, we turn to past conflicts. During the 1990 Gulf War, oil prices spiked briefly before collapsing as the U.S. deployed strategic reserves and Saudi Arabia ramped up production. The Fed, under Alan Greenspan, prioritized economic stability, allowing rates to drift lower as the conflict resolved swiftly.

The 2003 Iraq invasion, however, presented a different challenge. Oil prices surged to $50/barrel, and the Fed's aggressive easing—13 rate cuts by 2003—failed to offset the economic fragility of the time. A “war premium” in oil prices persisted, stifling growth and amplifying the housing bubble's eventual burst.

Current Fed Dilemma: Inflation or Growth?
Today's Fed faces a tougher calculus. Inflation remains elevated at 3.5%, but a prolonged Israel-Iran conflict could push energy prices higher still. A Fed that hikes rates to combat inflation risks exacerbating a potential economic slowdown from energy costs. Conversely, easing to support growth might let inflation linger.

The Fed's dual mandate is under strain. If oil prices stay elevated due to Hormuz risks, the central bank may lean toward patience, particularly if the conflict slows global manufacturing or consumer spending. A hawkish stance could backfire, as seen in 2022 when rate hikes coincided with energy-driven inflation.

Investment Implications: Timing the Risk Premium
Energy-linked equities—such as oil majors, refiners, and shipping firms—are the obvious plays here. But the Fed's policy response will determine their trajectory:

1. Short-Term Volatility, Long-Term Premium: Energy stocks (e.g., ExxonMobil (XOM), Chevron (CVX)) may see gains if oil stays above $75, but geopolitical flare-ups could cause roller-coaster moves.
2. Fed Easing = Equity Support: If the Fed cuts rates to offset growth risks, broader markets could rally, lifting energy stocks further.
3. Hedging Against Closure Risks: Shipping stocks like Maersk (MAERSK-B) or insurance firms might benefit from rerouting costs, but geopolitical escalation could amplify losses.

The Timing Edge
Investors should monitor two key triggers:
- Hormuz Closure: A full blockade would send oil to $100+, forcing the Fed into a corner. Equity markets might crash, but energy stocks could decouple.
- Fed Policy Shift: A dovish pivot by the Fed in Q4 2025—acknowledging growth risks from energy costs—would create a “sweet spot” for energy equities.

Conclusion: Position for Geopolitical and Monetary Crosscurrents
The Israel-Iran conflict has transformed the Strait of Hormuz into a geopolitical and economic flashpoint. Energy markets are pricing in risk, but the Fed's response will determine whether this translates into sustained gains or a fleeting spike.

Investment Advice:
- Overweight energy equities if Fed easing becomes imminent, but pair them with hedges like inverse oil ETFs (SCO) to mitigate volatility.
- Avoid overexposure to shipping or insurance stocks unless you can stomach extreme downside from a Hormuz closure.
- Watch the Fed's language on inflation expectations: Dovish signals could unlock a multi-month rally in energy-linked assets.

The next six months will test whether this conflict's risk premium can outlast the Fed's resolve to control inflation—a balancing act with profound implications for portfolios.