Fed Rate Hikes and Oil Prices: Why This ‘Stagflation’ Has Left the Fed in a Tight Spot

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This article was written on 21 October 2026; the data is current as at 20 October 2026. The dates of the two Federal Reserve meetings mentioned in the article—27–28 October and 8–9 December—are subject to the calendar in effect at the time of publication.

NOTES

Soaring oil prices, virtually stagnant employment, and a Federal Reserve that is still raising interest rates

Let’s look at three things first.

Firstly: Brent crude is currently trading at US$109 per barrel. Following military action against Iran by the US and Israel at the start of the year, oil prices have risen steadily; in September, US petrol prices rose by 34.2 per cent year-on-year.

Secondly: US non-farm payrolls rose by just 29,000 in September. By comparison, the figure for August was 133,000. The unemployment rate, meanwhile, rose to 4.2 per cent.

Thirdly: The Federal Reserve raised interest rates just last month, bringing the federal funds rate to 3.75 per cent–4.00 per cent, and the market is still betting on another hike in December, with the probability having been priced in at as high as 94 per cent at its peak.

With these three things happening at the same time, something just doesn’t seem quite right. Prices are rising, jobs are becoming scarcer, and the central bank, far from rescuing the economy, is actually slamming on the brakes?

If you find this unreasonable, congratulations—your intuition has picked up on a genuine contradiction. This article explains exactly why this contradiction exists, why the Federal Reserve finds itself in a bind, and how it relates to your and my mortgage, petrol costs and savings.

What actually happened: a concise list of facts

Let’s start by looking at the key figures (see the end of the article for data sources):

Indicators	Latest value	Previous figure	Notes
CPI year-on-year (September)	3.7%	3.4%	Of these, energy rose by 20.4 per cent and petrol by 34.2 per cent
Core CPI (September)	2.6%	—	Excluding energy and food, the figures are actually quite moderate
PPI (September)	6.3%	—	Producer prices are rising even more sharply
Non-farm payrolls (September)	+29,000	+133,000	Unemployment rate: 4.2 per cent; hourly wages up by just 3.0 per cent year-on-year
Federal Funds Rate	3.75%–4.00%	3.50%–3.75%	Interest rates were raised by 25 basis points on 16 September, with the decision passed unanimously (12–0).
10-year US Treasury yield	5.11%	—	An increase of approximately 113 basis points over the course of a year
Brent crude oil	US$109.3	—	Oil prices remain high following the attack on an oil tanker in the Strait of Hormuz

Comparison of year-on-year changes in various price and cost components in the US, September 2026

Figure 1The sharpest rise was seen in the oil price chain, whilst food and core inflation remained virtually unchanged—a classic sign of a supply shock.

This table actually tells a story: price rises are concentrated in the energy sector, whilst those that have not risen (food: 2.5 per cent; core: 2.6 per cent) are all very moderate.

Why is it unreasonable, and why is it reasonable?

Normal inflation is caused by ‘too much money and too few goods’: when the economy overheats, people rush to spend, and businesses, unable to recruit staff, are forced to raise wages, which in turn drives up prices. In this case, raising interest rates is effective: by increasing interest rates, consumption and investment cool down, and prices naturally fall.

But not this time.

Year-on-year trends in the US CPI and core CPI over the past 12 months, and the surge in energy prices in September

Figure 2The overall CPI jumped to 3.7 per cent in September, whilst core inflation stood at just 2.6 per cent; the rise was almost entirely driven by energy prices.

The source of this inflation is very clear: the Middle East. Since fighting broke out in late February, oil prices have been on an upward trend; in September, the energy sub-index rose by 20.4 per cent year-on-year, with petrol up 34.2 per cent, leading to a 6.3 per cent rise in the PPI (Producer Price Index). By contrast, core inflation—excluding energy and food—stood at just 2.6 per cent, whilst food inflation was only 2.5 per cent. In other words, the domestic US price system itself is not overheating; it is imported energy that is driving up the overall figures.

Demand is actually cooling further. In September, only 29,000 new jobs were created, the unemployment rate rose to 4.2 per cent, and hourly wage growth stood at just 3.0 per cent – none of which are characteristics of an overheating economy. Consumption does indeed show resilience, but the quality of this resilience is questionable: in August, personal disposable income grew by just 0.3 per cent, whilst consumer spending rose by 0.9 per cent; the extra spending came from savings, with the savings rate having fallen to 4.1 per cent. Consumption propped up by existing savings cannot be considered a sign of truly robust demand.

This explains that ‘irrationality’: the current inflation is supply-shock driven; the Middle East holds the reins on oil prices, and no matter how aggressively the Federal Reserve raises interest rates, it cannot conjure up a single oil tanker. The tools and the problem to be solved are simply not a good match.

Schematic diagram illustrating the transmission mechanism between supply shocks and interest rate hike cycles

Figure 3The chain of transmission of supply shocks: interest rate rises can curb demand, but they cannot control oil tankers.

So why is the Federal Reserve still raising rates? Because what it really fears is not the current CPI figures, but inflation expectations. Once businesses and households come to believe that ‘prices will keep rising’, wage and pricing behaviour will follow suit, at which point inflation will truly become uncontrollable. Therefore, the purpose of raising interest rates is not to suppress oil prices, but to signal to the market that the central bank is not standing idly by and that the 2 per cent target remains in place. This is a gamble that oil prices will fall of their own accord, whilst using interest rates to keep inflation expectations in check.

Incidentally, here is an intriguing detail: the resolution passed on 16 September was adopted unanimously by a vote of 12–0, with the statement noting that ‘employment growth is in line with the labour force’. However, with non-farm payrolls at just 29,000 and the unemployment rate rising to 4.2 per cent, there is a clear disconnect between this statement and the figures. How should this be interpreted? One possibility is that the new Chairman, Warsh, deliberately downplayed the weakening in the labour market to leave room for continued tightening; another is that the single-month non-farm payrolls figure was affected by ‘noise’ such as statistical adjustments and changes in the labour force base due to immigration, and that actual employment conditions were not as poor as the surface figures suggested. There is currently no conclusive evidence to support either interpretation; next month’s employment report (to be released on 6 November) will provide further clues.

What does this mean for ordinary people?

No matter how impressive the macroeconomic figures may seem, they ultimately come down to the bill.

Mortgage rates: 7.5 per cent, and still rising. According to MBA statistics (as reported by the media), the 30-year fixed-rate mortgage rate reached 7.50 per cent in the week of 9 October, marking the eighth consecutive week of increases and a cumulative rise of approximately 141 basis points since the outbreak of hostilities at the end of February. Historically, the long-term average for 30-year mortgage rates is 6.08 per cent, having fallen to a low of 2.85 per cent at the end of 2020. A rough calculation shows that for a 30-year mortgage of US$400,000, if the interest rate rises from 3 per cent to 7.5 per cent, the monthly repayment would increase from approximately US$1,686 to US$2,796. The extra US$1,110 or so represents the real cost borne by homebuyers in recent years. Homebuyers are naturally voting with their feet: mortgage applications have fallen for six consecutive weeks, and applications to purchase a home dropped by a further 4 per cent last week.

Comparison of monthly repayments for a 30-year fixed-rate mortgage of US$400,000 in the US

Figure 4For the same property and the same loan amount, the monthly repayment is $1,110 higher.

Petrol prices: The bill at the petrol station is the most obvious indicator. Petrol prices are up 34.2 per cent year-on-year, representing a fixed monthly additional outlay for commuters. With the autumn and winter heating season fast approaching, heating fuel prices have risen by 74.2 per cent year-on-year, meaning heating costs will be significantly higher this winter.

Savings: A savings rate of 4.1 per cent means the financial cushion is very thin. Consumption is still growing, but this is being fuelled by the drawing down of savings. Should oil prices rise again, or should the labour market continue to weaken, it is this consumption—which is being sustained by people’s savings—that will be the first to contract.

Car loans and credit cards: As I have not been able to verify the latest interest rate figures for these two items from a reliable source, I shall not quote any specific figures. However, the general trend can be reasonably inferred: as they are linked to the benchmark interest rate and banks’ funding costs, they will only rise, not fall, during an upward cycle in interest rates.

My assessment: The market may have overestimated the likelihood of a rate rise in December

Current market pricing suggests an approximately 83 per cent probability of no rate change at the 27–28 October meeting, whilst the probability of a rate rise at the 8–9 December meeting fluctuates between 75 per cent and 94 per cent. The prevailing view is that the Bank will ‘wait and see’ in October and raise rates once more in December.

I take a different view:I believe the probability of a rate rise in December has been overestimated; the scenario of ‘no change in either October or December’ (which I put at around 35 per cent) is more likely than the market is pricing in. There are three reasons:

Firstly, the structural driver of inflation is oil prices, not demand. Provided the situation in the Middle East does not deteriorate further, the base effect on oil prices is likely to subside of its own accord in the fourth quarter, at which point the CPI will fall, and the Federal Reserve will have no need to raise rates further.

Secondly, employment figures are deteriorating. If the 29,000 new jobs represent a trend rather than a blip, continuing to raise interest rates would be like placing another weight on an already fragile labour market. At the IMF Annual Meeting in Bangkok, Warsh offered no indication regarding the October meeting, stating only that ‘higher-than-expected inflation has not altered the assessment of the economy’ – a remark that seemed more intended to leave room for manoeuvre than to signal forthcoming action.

Thirdly, the marginal effect of interest rate rises does not, in any case, affect oil prices; an additional 25 basis points would offer virtually no direct benefit to CPI; on the contrary, it would further push up the 10-year government bond yield—which has already reached 5.11 per cent—and mortgage rates—which stand at 7.5 per cent—causing immediate damage to the housing sector.

What evidence would overturn my assessment? Two things: firstly, the employment report on 6 November showed that the labour market is regaining strength (with job creation returning to over 100,000), indicating that the demand side is genuinely overheating; secondly, the CPI figures for 10 November showed that inflation, excluding energy, has also begun to rise (with the month-on-month core rate rising consecutively), indicating that the oil price shock has already spilled over into wage and service pricing behaviour. Should either of these two events occur, I will shift my stance to support a rate rise in December.

Conversely, if rates are indeed raised in December, please bear in mind that this is a move intended to ‘stabilise expectations’ and does not mean that inflation has genuinely spiralled out of control; this can be verified by examining the core components of the next CPI figure.

The knock-on effects on the markets, and on the Australian dollar and the renminbi

The bond market has already priced in these expectations of ‘higher for longer’: 10-year US Treasuries are yielding 5.11 per cent, whilst 30-year bonds are yielding 5.43 per cent (Trading Economics, 20 October 2026). US equities are hovering near historic highs, but technology shares are falling: the Nasdaq has dropped by 3.7 per cent over the past month, and the market is beginning to re-evaluate the highly leveraged financing of AI data centres (the sharp fall in CoreWeave’s bonds is a sign of this). The US Dollar Index stands at 101.7 and the price of gold at US$4,125, both reflecting the same macroeconomic narrative.

A quick note for readers in Australia and those following the renminbi: whilst the Federal Reserve is tightening monetary policy, the Reserve Bank of Australia (RBA) has also been raising interest rates this year (the cash rate has now reached 4.60 per cent). With both central banks tightening simultaneously, the renminbi faces interest rate differential pressure against both currencies, and the short-term depreciation pressure is greater than I had anticipated inThe previous analysis of the RBA and the AUD/CNY exchange rateIt is stated more broadly in the text; however, if the Federal Reserve were to begin cutting interest rates in 2027 due to a deterioration in the labour market, the Australian dollar’s interest rate differential advantage would also narrow ahead of schedule. Whilst the mechanism has changed, the medium-term directional conclusion that the Australian dollar will remain ‘relatively weak’ remains unchanged for the time being, though the trigger point may be brought forward.

Conclusion

The most ironic aspect of this round of ‘stagflation’ is that whilst Washington holds no sway over inflation or employment, it is the hand that presses the button to raise interest rates. All the Federal Reserve can do is stabilise expectations and then wait for oil prices. If they fall, there will be a soft landing; if not, another rate hike will be necessary in December, and every ounce of that stagflation will ultimately land on the bills of ordinary households, from monthly mortgage repayments to petrol station receipts.

6 November and 10 November: two dates, two sets of figures, which essentially seal the fate of the first season of this story.

Data sources and notes

• Federal Reserve decision of 16 September (interest rate raised to 3.75 per cent–4.00 per cent, passed 12–0):federalreserve.gov
• CPI series (CPIAUCSL, BLS raw data obtained via FRED):fred.stlouisfed.org; Unemployment rate time series:fred.stlouisfed.org. High confidence
• Non-farm payrolls +29,000: Trading Economics, citing the BLS (tradingeconomics.com), within the confidence interval
• 30-year mortgage rate: 7.50 per cent: MBA statistics, as cited by Trading Economics (tradingeconomics.com）
• 10-year yield 5.11 per cent, US Dollar Index, oil prices, gold prices: Trading Economics (data as at 20 October 2026)
• The scenario probabilities are estimates made by the author based on open market pricing and fundamental analysis; they are provided for reference only and do not constitute investment advice.

Cover image:Jan Zakelj / Pexels