Outlook | Much ado about the Strait of Hormuz

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By Edward von der Schmidt

2026-08-16

President Trump's gamble in the Middle East has not paid off. After threatening escalation, the White House has not followed through and Iran has hardened its position as a consequence. The US and Iran are in something of a stalemate, with military brinksmanship giving way to probing provocations and an economic war of attrition. Absent diplomatic progress, who can afford to hold out longer? What sacrifices will be required? Can they be endured?

Iran has discovered a deterrent that is arguably more effective than nuclear weapons: leverage over the Strait of Hormuz and Middle East energy supplies. By restricting transit through the Persian Gulf and Red Sea, Iran and its allies have been able to disrupt oil, natural gas, fertilizer, and other markets critical for transportation, industry, and agriculture. The resulting "shock" of acute and possibly sustained shortages of key commodities risks higher fuel, shipping, and food prices globally. This can feed into higher prices across the economy and impede growth, a political cost the Trump administration would like to avoid going into the November midterm elections.

While Iran may seek to exploit such political pressure amid dwindling US armaments to extract negotiating concessions, the country faces tremendous hardships of its own. After violently quelling protests earlier this year, Iran's currency has weakened further as costs have soared and its economy remains in tatters. Sanctions have crippled Iran's ability to bring in revenue even before a US naval blockade. Much of its money is also frozen or tied up abroad. Now the US Treasury plans to announce further measures to tighten the screws. By playing hardball to secure a pivotal international waterway and geopolitical clout for itself, the Iranian regime is hazarding a collapse from within.

What does this no man's land mean for the global economy? In order to maximize the value of its leverage over the Strait of Hormuz, Iran and its allies will presumably attempt to make alternatives equally perilous. The greater the perceived risks of transit through these waterways, the less ships will roll the dice and the more dangerous it will be for those that do. This is how isolated missile and drone attacks can bring regional shipping to a crawl.

Even a trickle is better than a complete blockage, however, so the status quo might allow for a more manageable adjustment - provided that strategic reserves are sufficient and output can be made up elsewhere (or smuggled through). On the other hand, Iran could respond to US economic pressure and test a lack of military action by cutting off trade through the Strait of Hormuz, Bab al-Mandeb strait, and even the Suez Canal while targeting pipelines and other land-based infrastructure.

A slow and steady climb in oil and fuel prices could become disorderly instead and reintroduce the sort of heightened volatility that ignites inflation and hinders economic decision-making and activity. Given this scenario, would the US be prepared to recognize Iran's long-term claim to the Strait of Hormuz in order to avoid the immediate fallout, to the chagrin of Middle East partners? If both are content to bide their time, might the US and Iran choose to accept unresolved, latent hostility as preferable to active confrontation?

Extended energy supply shocks, where shortages lead to broader, self-sustaining price increases, are a critical risk to US (and global) inflation. Although tariffs' effects appear to be passing through (i.e., a transitory, one-time increase in the price level), higher fuel and food prices from the Middle East conflict, higher grain prices from the Russia-Ukraine war, and higher chip, memory, and other component costs from AI demand represent the type of potent combination that kick-started global inflation during the pandemic. This can also entrench self-fulfilling expectations of rising costs.

In turn, higher prices could curtail spending and investment while eating into profitability and growth. Higher borrowing costs due to inflation risks and burgeoning issuance could also prove to be a headwind, especially for companies relying on debt financing. While slower growth might normally be expected to reduce upward pressure on prices, this is not necessarily true for supply-driven inflation. In that case, there simply isn't enough of what is needed - a problem that tighter monetary policy (which throttles demand) might not be able to solve.

US growth is solid if unremarkable but has hinged on the AI buildout boom. Resilient labor markets appear to be treading water near full employment but remain susceptible to employer cost-cutting. Inflation is easing slightly but is still well above target and not out of the woods yet. The economy may well muddle through. But if "stagflation" (low growth, high inflation) begins to emerge and the Fed weighs the difficult decision to tighten in order to deliver price stability, will President Trump let them? Or will he use his executive authority to gamble the central bank's independence - a bedrock of global financial stability - as well?

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