June 5, 2026
If there was any doubt, the employment report for May confirmed that the economy is gathering momentum. Following a year when employment was barely climbing, jobs growth in recent months has quickened to about 180 thousand. The long dormant manufacturing sector has turned upwards. Second quarter GDP growth is likely to exceed 3.0%. Meanwhile the core CPI inflation rate continues to climb at a 2.7% pace which is still well in excess of the Fed’s 2.0% inflation target. That GDP growth/inflation combo has made market participants nervous and they currently expect the Fed to tighten 0.25% by yearend. Whether that happens or not will depend to a large extent on re-opening of the Strait of Hormuz. If the Strait re-opens to commercial traffic oil prices will fall and the inflation problem will largely go away. But if it doesn’t re-open soon oil prices and inflation will worsen and force the Fed into tightening mode. That is because right now oil demand far outpaces supply and global oil inventories have shrunk to a record low level and are declining every month. If the Strait remains effectively closed oil prices will steadily climb and boost the inflation rate further. The key to avoiding this situation is a resumption of the flow of oil through the Strait of Hormuz.
Payroll employment for May rose 172 thousand. In the past three months employment gains have averaged 188 thousand per month. That is in sharp contrast to the average monthly gain of just 10 thousand in 2025. Business leaders and consumers have largely shrugged off higher tariffs, deportation of illegal immigrants, federal government layoffs, the prolonged end-of-year government shutdown, and the war with Iran that began in late February. The fear late last year was that the economy was on the cusp of recession. That has yielded to a concern that the economy is gathering momentum and higher rates will be needed in the months ahead to cool things down.
The problem is not with the acceleration in GDP growth. That is being driven by spending on technology in general, AI in particular. As a result productivity growth has surged in the past year to 2.8% after having risen a meager 1.2% in the previous ten years.
The gain in productivity has boosted the economy’s speed limit from 2.0% to about 3.0%. That means that the economy can safely grow at a sustained 3.0% pace without putting upward pressure on the inflation rate. With GDP growth in the past year of 2.5% the economy is not yet exceeding the speed limit. No problem on the growth front.
Inflation is a different story. The war with Iran has caused gasoline prices to jump 50% from about $3.00 per gallon prior to the war to $4.50.
The rise in gasoline prices has caused the overall CPI inflation rate to climb from 2.5% to 3.8%. The core rate (excluding the volatile food and energy components) thus far has not been significantly affected. It was running at about 2.5% prior to the war versus 2.7% currently. The inflation problem is all oil-related which takes us to the Strait of Hormuz.
President Trump apparently did not count on Iran being able to close the Strait of Hormuz through which about 20% of the world’s oil supply passes. As a result, transit calls through the Strait have dropped from about 100 per day prior to the war to 5 or fewer currently. Ships are rerouting via the Cape of Good Hope which adds about 14 extra transit days to the voyage and drastically increases shipping costs. Currently about 250 ships are at anchor in the Persian Gulf awaiting permission to pass through the Strait. As a result of this, global oil supply has shrunk dramatically. Instead of supply and demand being roughly equal, the global supply of oil today is running about 8.5 million barrels per day less than demand (the blue bars).
To make up for the supply shortfall countries are dipping into oil inventories which have shrunk every month since the war started and are now at a record low level. If the Strait remains closed those inventory levels will fall further and, inevitably, prices will continue to climb.
Talk that negotiations between the U.S. and Iran have achieved some success has caused crude oil prices to fall from a peak of about $115 in early April to $90. But if the Strait remains close oil prices will rebound and could easily exceed their previous high level.
For now Fed Chair Warsh and his colleagues should refrain from hiking rates, but they may well adopt a tightening bias at their upcoming meeting on June 16-17. Unfortunately, the outlook for interest rates in the months ahead is less dependent upon Fed action than it is on an event that may or may not happen on the other side of the world.
Stephen Slifer
NumberNomics
Charleston, S.C.
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