A Truce With Iran Sent Oil Tumbling. For Now.

As of today, June 22nd, the war between Iran and the United States appears to have entered a fragile truce, at least for now. Oil has fallen to its lowest level since early March, around $74 a barrel for Brent crude. The framework agreement between Iran and the United States, reached days earlier, announced a halt to roughly four months of fighting, an extension of the ceasefire, and the reopening of the Strait of Hormuz, the thin waterway between Iran to the north and Oman to the south through which around a fifth of the world's oil is shipped every day. The framework also laid out a 60-day road map toward a final agreement.

For those who have watched with rising consternation as gas prices climbed all spring, the war between the United States and Iran had become one of the biggest contributors to higher inflation this year. And now, that war is, for the moment, winding down.

Why the Strait of Hormuz Runs the World

It is so narrow that at its tightest point only about 21 miles of water separate Iran from Oman's Musandam Peninsula. Crude oil flowing from the oil fields around the Persian Gulf is loaded onto tankers in ports along the Gulf, and most of it is destined for refineries outside the Middle East, many of them in Asia, especially in China, India, and Japan. The tankers are sent through the Strait of Hormuz on their way to their final destination. Roughly a fifth of the world's oil is shipped this way.

Oil is priced on the global market, and it does not matter to the U.S. consumer that the United States produces a huge amount of oil for itself. What matters is that when traders fear a fifth of the world's supply could be disrupted, the price of all the oil on the global market goes up. That is what happens when so much of global supply is suddenly at risk. The higher price of oil ripples outward, raising the cost of growing and moving food and of nearly everything else that takes a lot of energy to make. Because energy is an input into so many products, it can drive up the price of many goods, and it has been the source of a large portion of the recent increase in the Consumer Price Index, where energy accounted for over 60% of the most recent monthly increase.

How This Fed Into Everything Else

The energy shock caused by the war is also a big reason the Federal Reserve has been unable to cut interest rates even as the broader economy has begun to slow. The war has been quietly setting the price of your mortgage as much as the price of your gasoline. So if oil is now falling, the logic runs in reverse. As oil falls, energy prices should eventually fall, which in turn should bring down inflation, freeing the Fed to lower interest rates after more than a year of holding them steady.

The $300 Billion Catch

While the agreement is primarily about oil and ending four months of war, the framework also includes the initial stages of a plan worth at least $300 billion to help Iran rebuild, covering reconstruction of war-damaged refineries, the steel industry, and even the country's airports. There are also hoped-for negotiations to unlock an initial $24 to $25 billion in Iranian assets frozen abroad. The administration has repeatedly said that any reconstruction funding would come not from the U.S. taxpayer but from regional partners. The figure has, however, quickly become a political hot potato, with critics in both parties slamming the terms of any agreement that would send funds toward rebuilding a country the U.S. was at war with weeks ago.

How Fragile This Really Is

While a framework has been reached, it is far from a settled peace. Already, the talks that were set to take place in Switzerland on June 19th were postponed. And this past weekend, Iran announced a renewed closure of the strait, claiming it was in response to Israeli operations in Lebanon and U.S. "bad faith" in negotiations, while the U.S. rejected the closure and said the strait remained open. As of Monday, traffic through the strait was actually up, and the two sides announced a 60-day roadmap to finalize a deal. The back and forth over the strait in the space of a single week highlights just how fragile the current situation is.

But markets are pricing in a peace that has not yet been formally inked, and that can change very quickly. If talks collapse over the next two months, the strait could be shut for real, sending the price of oil soaring once again. On the other hand, even if the truce holds and oil keeps falling, it will take time for that lower price to filter down through the supply chain and show up in stores. Gas prices will fall quickly, but just about everything else will take months to drop.

The Bottom Line

As of June 22nd, the war between the United States and Iran has, for now, given way to a fragile truce, and oil has fallen with it. But the real test comes over the next 60 days, as negotiators try to turn the framework into a final deal. That deal has to address both Iran's nuclear program and the rebuilding of the country, including a contested $300 billion reconstruction fund and some $24 to $25 billion in frozen Iranian assets, an arrangement many already see as a giant payout to Tehran. If that piece falls apart, the deal is worth far less than markets assume, and oil could snap higher again. The relief at the pump is real, but the war is by no means over yet.