August 30 Comprehensive Analysis of the Fed’s Rate Hike: The Three-Way Game Between Inflation, Crude Oil, and the Midterm Elections

The Federal Reserve’s interest-rate decisions have never been the product of a single data point, but rather the result of the combined impact of inflation, energy, and the political cycle. Today, we will start from the underlying logic and break down the core dilemma behind whether the Fed will raise rates.

I. The Underlying Logic of Fed Rate Hikes: The Dual Anchors of Employment and Inflation

The Fed’s core indicators for determining monetary policy have always centered on employment and inflation. However, employment data is subject to frequent revisions and is used more by the Fed as a tool to “adjust market expectations.” The most immediate pressure in reality comes from the inflation data itself.

II. Before the Midterm Elections: The Fed’s Three-Part Logic for “Standing Pat”

The Fed’s decision-making takes the “midterm elections” as a clear dividing line. Before the elections, its core goal is to preserve its independence and avoid being labeled as “interfering in the election,” giving it ample reason to maintain policy stability:

1. Avoiding significant policy shifts: Before the midterm elections, the Fed will avoid major adjustments to monetary policy as much as possible, preventing the ruling or opposition party from exploiting the issue to question its independence.

2. Awaiting reports from five working groups: The Fed is advancing research and studies through five new working groups. The relevant reports and policy recommendations have not yet been released, providing a reasonable buffer for temporarily “standing pat.”

3. Hedging the inflation risks from the Middle East situation: The potential risk of Iran escalating the situation in the Middle East is the biggest source of uncertainty before the midterm elections. If Iran attacks commercial vessels, expands the conflict, or strikes energy infrastructure, it will directly drive a rapid short-term rise in crude oil prices, which will feed through to inflation indicators such as CPI and PCE and intensify rate-hike pressure from the hawkish camp. To this end, the Fed has already laid out multiple hedging measures:

◦ Releasing shipping data on the Strait of Hormuz: By releasing information about large volumes of oil being shipped out, the Fed can stabilize market expectations for crude oil supply;

◦ Reaching a U.S.-Venezuela oil agreement: Gaining majority control over Venezuela’s 65 billion barrels of proven oil reserves, with the core aim of pushing down oil prices and lowering the public’s and voters’ expectations for energy costs;

◦ Holding a meeting with refining company executives: On September 1, at least ten refining and fuel-retail giants will be convened, with the goal of lowering retail gasoline and diesel prices while expanding capacity, thereby “cooling” policy adjustments at the mid-September rate-setting meeting.

III. The Chain Reaction of a Rate Hike Before the Midterm Elections: Triple Impact on U.S. Stocks, the Dollar, and Treasuries

If the Fed is forced to raise rates before the midterm elections, it will directly trigger a series of real-world problems:

• Pressure on U.S. stocks: A rate hike would directly weigh on U.S. stock performance, while continued record highs in U.S. stocks are an important market signal. Any weakening would directly affect voter confidence;

• A surge in the U.S. Dollar Index: A rate hike would push up the U.S. Dollar Index, and combined with subsequent policy adjustments by the Bank of Japan, would further intensify volatility in the yen exchange rate, creating a countervailing impact on U.S. stocks and Treasury markets;

• Treasury interest costs postponed: Before the midterm elections, Treasury interest costs are a lower-priority concern. The Fed can adjust the timing through a “raise rates first, cut rates later” approach, postponing this pressure.

IV. Flexibility in the Inflation Target: The Possibility of a Flexible Adjustment from 2%

Fed Chair Warsh has explicitly stated that inflation remains above target and that the Fed still has work to do. Returning inflation to 2% is the core goal, but he did not clearly say that this “work” means raising rates. This suggests that the Fed may adjust how inflation is measured:

• Drawing on the Bank of Canada’s allowance for inflation to fluctuate within a 1%-3% range and the Reserve Bank of Australia’s 2%-3% inflation target;

• Using statistical methods such as the “trimmed mean” to exclude extreme indicators and effectively loosen inflation tolerance. Relevant adjustments may receive support in future reports.

V. After the Midterm Elections: Constraints and New Considerations for Rate Hikes

After the midterm elections, short-term constraints will be removed, and the Fed’s decisions will return to inflation itself. If inflation indicators are not adjusted, it will directly face inflationary pressure transmitted through energy prices. At that point, a rate hike will face two major practical pressures:

• Yen exchange-rate volatility: A rate hike would further intensify instability in the yen exchange rate, creating a countervailing impact on U.S. stocks and Treasuries;

• Pressure from Treasury interest expenses: After the midterm elections, pressure from Treasury interest expenses will rise significantly.

More importantly, a rate hike would directly increase borrowing costs for technology companies and hinder the development of the AI industry—which is the core growth engine Warsh places high hopes on to drive rapid U.S. economic growth. Once rates rise, the narrative that “AI will drive an economic boom and keep inflation low over the long term” will be directly obstructed.

VI. The Ultimate Core Variable: Uncertainty Surrounding the Middle East

The most uncertain factor at present and going forward, and the one with the most direct impact on inflation, remains whether Iran will actively escalate the situation in the Middle East. The rate-setting meetings in September and October will both face a real-world test of this potential risk.

VII. Conclusion: The Fed’s Dilemma

If the Fed chooses to raise rates, it is essentially prioritizing the resolution of its own inflation problem at the expense of global economic interests, but this will directly hit the AI industry and the long-term drivers of economic growth. If it chooses not to raise rates, it will have to bear the pressure of persistent inflation and may even adjust its inflation target. Ultimately, the decision will still have to await greater clarity on the Middle East situation, energy prices, and inflation data.