On Wednesday the Federal Reserve raised its policy rate to 3.75 to 4.00 percent, the first increase since 2023. That much was expected. Markets had largely priced the move since last week's oil rally, and the decision was unanimous, twelve votes in favour and none against. The news was not in the number.
It was in the press conference. Kevin Warsh, who since taking office has explained as little as possible, this week answered the question that has occupied markets since August. Can a central bank do anything about an energy shock? "We can't affect any individual price, whether it be oil prices, whether it be foodstuffs at the grocery store." So the Fed did not raise rates against the oil price. It raised them against the risk that the oil price settles into expectations.
Last week the barrel filled the vacuum the Fed had left behind. This week the Fed took that place back. Markets responded in a way the textbook does not describe.
The hike arrived, and so did the reasoning
The statement stayed short without being empty. The committee said activity is expanding solidly, that job gains are keeping pace with the workforce, and that the decision supports "a timelier return to the Committee's 2 percent goal." More important than the wording was the vote. Where earlier meetings had produced dissents from governors who wanted to tighten, the committee now stood behind the move in full.
The projections gave the decision its weight. Participants see the policy rate at 4.1 percent at the end of this year and staying there through next year. Twelve of eighteen expect one more increase in 2026, four see two, two see none. PCE inflation is put at 3.7 percent for this year and 2.3 percent for 2027. Growth comes in at 2.3 percent and unemployment holds at 4.1 percent.
The number that matters is not this year's but next year's. In March the same committee still expected cuts. Now it projects a rate that does not fall for eighteen months, in an economy its own forecast has growing normally throughout. That is not a pause. That is a ceiling that stays in place.
Core inflation is the lowest since 2021
The August reading published last Friday was the final input the committee received. Headline consumer prices rose 0.4 percent on the month and 3.4 percent on the year. Core came in at 0.3 percent and 2.4 percent annually, the lowest level since March 2021.
The entire gap between those two figures is energy. Gasoline rose 3.9 percent in a single month and 27.4 percent over the year, fuel oil 52 percent, the energy component as a whole 16.3 percent. Shelter cooled to 3.0 percent, food to 2.7 percent, and core goods excluding food and energy rose just 0.7 percent.
Warsh named it himself. Core PCE and core CPI are running at roughly 3.2 and 2.4 percent by his own account. So the Fed tightened at the moment underlying inflation is at its weakest in five years, while the headline is being driven by precisely the price the chairman says he cannot touch. That is only coherent if the target is not the price. The target is the expectation.
The bond market rewards the tightening
The first reaction was the conventional one. On Wednesday the Dow lost 718 points, the S&P 500 fell 0.64 percent and the Nasdaq gave up 0.31 percent. Bank shares took the worst of it, with Bank of America and Wells Fargo each three percent lower. The two-year yield rose five basis points to 4.717 percent and the ten-year held just above five percent, at 5.008.
Thursday turned the picture around. The ten-year eased for the first time in eight sessions, to 4.989 percent, the thirty-year slipped to 5.337 percent, and by Friday the ten-year stood near 4.93 percent. The S&P 500 gained 1.14 percent to 7,639 points and the Nasdaq 1.69 percent, with Micron up 5.5 percent and Intel 7.7 percent.
A curve that falls after a hike is not a curve fearing a policy error. It is a curve unwinding the inflation premium it had built over the preceding weeks. A second factor helped: the president said an end to the seven-month war with Iran could be near, which eased term premia across sovereign curves. Tightening costs money. Not tightening was proving more expensive.
Oil loses the wheel
The week began on the other side of that trade. The strike on the East-West pipeline, the Friday before, halted the route that carries four million barrels a day around the Strait of Hormuz, roughly four percent of global supply. Satellite images on Monday showed the extent of the damage, the same day Houthi forces hit the Khamis Mushait airbase with missiles and drones. Transits through Hormuz fell below ten a day against a ten-day average of fourteen. Brent stood at 106.93 dollars on Tuesday, WTI at 102.65.
Then it turned. Riyadh said it could restore half the capacity within days and all of it within six weeks, and deployed shuttle vessels to move the volume through Hormuz instead. Washington confirmed the restart. Reports that Beijing had pressed Tehran to restrain Houthi attacks on Saudi installations did the rest. Brent fell three sessions in a row, to 104.13 dollars on Friday.
Gold moved as its mirror image. The metal lost more than one percent on the decision, recovered 1.1 percent on Thursday to 4,310 dollars and closed the week near 4,359. Silver rose 2.9 percent to 65.52. That recovery did not come from rising inflation risk. It came from the Fed making clear it will not chase the oil price. The barrel steered for one week. No longer.
Europe and Japan tighten alongside
The ECB's increase to 2.50 percent took effect on 16 September, the same day as the Fed decision. Money markets now price roughly 85 basis points of further tightening through end-2027, with a December move fully priced and October distinctly live. The German ten-year sits at its highest since 2011, the French thirty-year at levels last seen in 2003.
Europe's problem, though, is not in the rate but in the meter. Gas settled at 76.64 euros per megawatt hour, more than twenty percent above a month ago and more than double a year earlier. Storage stands near 68 percent, low for the time of year. Qatari LNG is not reaching Europe through the Hormuz blockade, while Norwegian fields are in maintenance.
Japan closed the week with an increase to 1.25 percent, the highest since 1995, and a signal that more will follow. Surveys point to 1.5 percent by the end of March. Three central banks are tightening simultaneously into the same supply shock. America is tightening against an expectation. Europe is tightening against a winter.
Where this leaves the markets
On 30 September the August core PCE arrives, the first reading of the gauge this committee steers by since the hike. Warsh put the level at roughly 3.2 percent himself. A higher print turns the meeting of 27 and 28 October concrete quickly, and markets currently price around 53 percent odds of a move there. The ECB decides the following day.
Two other clocks are running that no central bank controls. The Saudi pipeline is meant to be fully back within six weeks, and Gulf leaders meet next week while Washington weighs further military action. European gas storage has until roughly November to close its gap.
Last week the market had to guess, and it looked at the oil price. This week it was given a sentence, and the sentence said oil is not the variable. What stands out is that the bond market rewarded that immediately. The Fed has said what it cannot do. The real test comes when it has to show what it will.
