Fed Holds Rates at 3.75%-4% Despite Inflation at 3.7%

The Federal Open Market Committee held its benchmark rate at 3.75% to 4% this week, even as US inflation ran at 3.7% — nearly double the Fed's 2% mandate. Two voting members broke ranks: Governor Lisa Cook and Cleveland Fed President Beth Hammack dissented in favor of a 25-basis-point hike. Chairman Kevin Warsh, who has talked tough on inflation since returning to the central bank this spring, chose the pause anyway.

The arithmetic is stark. Consumer prices rose 3.4% year over year in both July and August, then accelerated to 3.7% in September, according to the Bureau of Labor Statistics. Gasoline drove the jump, up 34.2% from a year earlier. Warsh did not dispute the numbers. "I am not going to be the guy who says that oil prices haven't gone up," he told reporters at his post-FOMC press conference.

Why hold rates while inflation runs hot?

The answer is geography, not economics in the textbook sense. The inflation pressure originates in the Middle East, outside the Fed's reach. The US conflict with Iran shows no sign of ending, despite President Trump's promises of a short war. Iran sits on both the Persian Gulf and the Gulf of Oman, straddling the Strait of Hormuz — the choke point for oil exports from Kuwait, Qatar, Saudi Arabia and the UAE. Roughly 20 million barrels a day pass through it, per 2024 figures from the Energy Information Administration. That is about one in five barrels of world supply.

Crude has traded above $100 a barrel since October 7. Russia's war in Ukraine compounds the squeeze by constraining another major production hub.

Treasury Secretary Scott Bessent and other economists have urged Warsh and the FOMC to "look through" the price pressure, preserving the Fed's traditional independence from both politicians and Tehran's interference in the oil market. In September — when the committee unanimously raised rates 25 basis points — Bessent framed that move as an effort to prevent a "broaden[ing] out" of the supply shock's impact. The implication is uncomfortable: last month's hike was containment, not conviction.

What does the hold signal about Tehran's leverage?

The decision, paired with market expectations of hikes at every other meeting rather than at each one, suggests the Fed will not let the oil shock dictate the rate path — and will not grant Iran an indirect vote on US monetary policy. The cost is credibility on inflation, which Warsh has called the Fed's "charge to keep." A 1.7-percentage-point overshoot of target is hard to reconcile with that language.

Iran's regime knows the leverage it holds in Washington, though its primary target appears to be the White House, not the Fed. Higher interest rates have famously drawn Trump's ire. Wilbur Ross, Trump's former commerce secretary, told Fortune in July: "We're about to go into the midterm elections, and so there's an unusual political factor which I'm sure both sides are aware of. The Iranians seem to be betting that they can outlast the president, and that has been a characteristic theory of their prior discussions."

Warsh, for his part, flagged a break in market behavior. "There's been a stable correlation between oil prices, as they've moved up this year generally, and interest rates. Not the interest rates that we control but the interest rates set in the market," he said yesterday afternoon. "Until very recently. We've seen oil prices continue to move up, largely due to geopolitical events … [but] interest rates have rolled over to the downside."

He added: "I am not a Wall Street newsletter, I'm just telling you, when I look out the window over the last several months, that is what we've seen. To the extent that oil prices were to move lower, again probably due to geopolitical events, that's something that we're going to have to interrogate. What are the effects on the Fed's dual mandate? What are the effects on financial market prices, and what are we going to do about it?"

How many "one-off" shocks can the Fed ignore?

Ahead of the meeting, UBS's Paul Donovan pressed the point with investors. "Oil prices are a one-off shock, beyond central banks' control. Unfortunately, they are the fourth successive one-off shock: pandemic supply chain issues, the Russian invasion of Ukraine, tariffs, and the Gulf war. Four successive temporary shocks give an illusion of permanence," he wrote.

Donovan's caveat cuts at the core of the Fed's stance. If temporary shocks arrive faster than they fade, "looking through" them becomes indistinguishable from tolerating permanently higher inflation. The Fed has now paused once; whether it can keep pausing with gasoline up 34.2% will depend on a war it cannot control.