Raise once, then wait and see — the Fed shouldn’t chase the oil price
Lena Dräger, Research Director of the Monetary Macroeconomics Group at the Kiel Institute for the World Economy, comments on the expected decision by the US Federal Reserve to raise the Federal Funds Target range by an estimated 25 basis points:
“The Fed should raise the Federal Funds Target range by 25 basis points to 3.75 to 4.00 percent on Wednesday, September 16, 2026—and that should be the only move for now. Higher interest rates do not lower the oil price. In the seventh month of the energy price shock, the focus is on something else: second-round effects and heightened inflation expectations, which monetary policy is well equipped to address.
The key indicator is the Personal Consumption Expenditures (PCE) price index, which continuously weights all household consumption expenditures based on actual purchasing behavior. The Fed bases its 2 percent target on this rate. In July, however, this rate stood at 3.7 percent; excluding energy and food, it was 3.3 percent. While the overall rate is above the core rate due to energy prices, the fact that the core rate is also above target shows that the shock is no longer limited to energy prices. At the same time, with a real policy rate of just over 0.3 percent at the short end, monetary policy is not restrictive, and according to the New York Fed’s Survey of Consumer Expectations, households’ inflation expectations continue to lie well above the inflation target at 3.6 percent over the next 12 months and 3 percent over the next five years.
The spread between regular and inflation-protected US bonds shows that investors expect inflation of only about 2.4 percent over the next ten years. Unlike households, the financial markets therefore continue to expect the Fed to meet its target. At the same time, job growth averaged only 31,000 jobs per month over the past twelve months, and the EIA expects oil prices to fall significantly again by 2027. In this scenario, the price surge would thus fade on its own in the coming year, while a series of interest rate hikes would place an additional strain on the economy. Nevertheless, an interest rate hike is appropriate to counteract the spreading price pressures and households’ high inflation expectations. Should the energy price shock persist longer, the Fed would have to reassess the situation. Fed Chairman Kevin Warsh has stopped the monetary policy tools of forward guidance and the dot plot; managing market expectations now rests entirely on the press conference. There, he should make it clear: the Fed is defending its inflation target against second-round effects—it is not chasing after the oil price.”
