US attack on Iran adds to economic uncertainty

Highlights:

• Economic outlook already uncertain due to tariff policy
• Fed Chair Powell to give Congressional testimony Tuesday, Wednesday
• Labor market, inflation data expected this week

The US bombing of Iran's nuclear sites injected fresh uncertainty into the outlook for inflation and economic activity at the start of a week chock full of new economic data and central banker commentary, including two days of Congressional testimony from Federal Reserve Chair Jerome Powell.

The downside of the attacks may be the easiest to see: the potential for a spike in energy prices, a continuation of the hesitancy that has gripped households and businesses and could crimp spending, and the possibility of a response from Iran that materializes well outside the Gulf.

With the US economy already expected to slow under pressure from the Trump administration's high import tariffs, a rise in oil prices resulting from the conflict "could provide powerful downward pressure on households' ability to spend... and that could slow GDP even more," Morgan Stanley Chief Economic Strategist Ellen Zentner said on Sunday.

There's also the more bullish case, should the attacks pave the way for eventual stability in the region.

"Predicting geopolitical developments in the Middle East is a treacherous exercise," analysts at Yardeni Research wrote after the attacks. "However, the Israeli stock market suggests that we may be witnessing a radical transformation of the Middle East now that Iran has been de-nuked."

Israel's Tel Aviv main index was at an all-time high after the attacks.

That said, the US labor market is clearly losing momentum, even as inflation pressures look set to increase.

Data due on Thursday for continued jobless claims will factor into the Labor Department's monthly jobs report for June. To date those reports have pointed to a softening but still-solid job market, with the unemployment rate at a relatively low 4.2%, but Fed policymakers keenly watching for signs of deterioration.

Data to be published on Friday is expected to show the weakest US consumer spending growth since January. And while it is also expected to show inflation running near the Fed's 2% goal last month, many Fed officials expect tariffs to feed into higher prices in coming months.

A sharp rise in energy prices could fan the embers of inflation further.

Powell will undoubtedly be pressed on that possibility and for other ramifications of Middle East developments during two days of Congressional testimony, beginning Tuesday at the House Financial Services Committee and continuing on Wednesday at the Senate Banking Committee.

Fed officials last week left the policy rate in its current 4.25%-4.50% range, and while policymakers signaled they felt economic conditions would likely warrant a couple of interest-rate cuts later this year, Powell said that forecast comes with little conviction, given all the uncertainty about tariff policy and how the economy will respond.

The weekend's US-Iran developments raise new questions about how uncertainty will impact Fed decision-making, wrote Wells Fargo senior economist Sam Bullard.

"The markets will be watching for clues as to how the Fed recalibrates the inflationary risks from higher energy prices and tariffs against the disinflationary pressures of slowing growth," he said.