On Wednesday, September 16th, the Federal Reserve announced that it would raise interest rates. Read that again: the Fed just raised rates into an inflationary oil shock that was already pushing prices higher.

The Federal Open Market Committee bumped its benchmark federal funds target up a quarter point, from 3.50% to 3.75% up to 3.75% to 4.00%. This is the Fed’s first hike since July 2023, and every single voting member signed off on it. The 3.50% to 3.75% target range resulted in an actual rate of 3.63%. If that was all it might not be too bad, but they are projecting more pain to come. But the spread between CPI with energy (blue) and without energy (red) tells a different story. Almost 1% of inflation is due to elevated oil prices. And raising rates might work on a monetary problem, but it does nothing to fix a supply problem.

Back in July, three FOMC members wanted a quarter-point hike while the majority voted to hold. By September, all 12 voting members were on board with raising rates.

What changed? Inflation stayed stubbornly above the Fed’s 2% target, and energy prices took off.

Here’s the thing, though: the Fed’s own statement paints a picture of an economy doing fine. Solid growth, resilient spending, strong productivity, and robust capital investment. This isn’t the Fed stepping in to rescue a faltering economy. It’s the Fed going after inflation, full stop.

That distinction matters a lot for what comes next.

A week ago, everyone still expected a hold. What’s striking is how fast the narrative flipped.

A September 4^th to 9^th Reuters poll found roughly 70% of economists expected the Fed to hold steady at this meeting. By September 14^th, the market had swung hard toward a hike.

Layer some politics on top of that. President Trump and Vice President Vance had been publicly leaning on the Fed to cut rates. If the Fed had cut or even held steady after that pressure campaign, it risked looking like it was caving to the White House.

That put the Fed in a strange bind. An institution trying to prove its independence might actually feel pressure to avoid appearing influenced in either direction. Whether that factored into Wednesday’s unanimous vote, we can’t know for sure. Officially, the Fed points to inflation and economic conditions as the reason.

Not all inflation is created equal. Fed Chair Kevin Warsh even acknowledged the largely powerlessness of monetary policy to address oil supply disruptions. Demand-driven inflation happens when people and businesses are trying to spend more than the economy can produce, often the result of the FED printing too much money in the first place. Raising rates works reasonably well here because it stifles borrowing, spending, and investment.

Supply-driven inflation is a different animal. When oil prices spike because of a shipping disruption or a supply cutoff, raising interest rates doesn’t put more oil on the market. It can knock down demand, sure, but only by slowing down everything else too. Borrowing costs are already high, why make them higher?

That’s the uncomfortable spot the Fed is in. It’s using a demand-side tool against a problem that is a supply-side problem. Using monetary tools to fix a supply issue is like using a hammer when you need a screwdriver; all you’ll get is a mashed-up screw.

The Fed’s updated projections (called the “dot plot”) make this whole thing more interesting. Think of the dot plot as the Fed’s forecast board. Each dot is one policymaker’s guess about future interest rates, and those guesses just moved higher. September’s dot plot shows a median federal funds rate of 4.1% by the end of 2026, up from 3.8% in June. So, most officials now expect at least one more hike.

That’s not a guarantee. The dot plot is a collection of individual guesses, not a policy promise. But the direction of travel is unmistakable. Wednesday’s move might just be the opening act. And moving from 3.63% to 4% is a hefty jump in less than 6 months.

There’s a reason to look back at history here. The 1994 tightening cycle is remembered for how fast and sharp the Fed’s hikes came. But unlike today’s environment, the Fed was responding primarily to demand-side pressures and a tightening labor market, not an oil shock or a major supply disruption.  The 2022 cycle is a more recent comparison. In 2022, the Fed hammered inflation after the pandemic, taking rates from near zero to above 5%. That inflation was partly monetary-based due to massive money printing and partly supply-based since production was massively curtailed due to the pandemic.

But today’s situation doesn’t correspond directly to either one, and tightening the monetary screws in the middle of a supply shock can create unintended consequences.

Stocks didn’t take Wednesday’s news well. The Dow dropped roughly 630 points. The S&P 500 slid about 0.45%, while the Nasdaq basically flatlined.

That reaction tracks with the obvious concern: higher rates raise the cost of capital, squeezing borrowing, investment, and asset valuations. Now those higher financing costs will compound expensive energy, not fix the problem. By Thursday, the markets had shrugged off the loss, but history tells us that the longer-term effects could still be a market correction.

If demand due to monetary stimulus were the whole story, a rate hike could make sense. But if a meaningful chunk of today’s inflation is the result of higher energy and transportation costs (and I think it is), raising rates is NOT a good idea. Higher rates will choke the economy without touching the actual bottleneck.

Put those pieces together, and you get a nasty combination: higher energy prices, higher borrowing costs, and slower growth, all at once. That’s the recipe for stagflation.

For now, the Fed has decided: it’s willing to tolerate tighter financial conditions in pursuit of its 2% inflation target. But even without tightening, our MIP Inflation Predictor wasn’t projecting massive inflation long term, although there may have been a slight increase early in 2027.

The Fed doesn’t think this ends quickly. Its own September projections put headline PCE inflation at 3.7% for 2026, easing to 2.3% in 2027 and 2.1% in 2028. The median projection doesn’t hit 2% until 2029.

So the question isn’t, “Will the Fed raise rates?” anymore. They’ve answered that. The real question now is: how much economic pain will hammering rates create?

On paper, a quarter-point hike looks modest. But stack it next to a 5% 10-year Treasury yield, elevated oil prices, and the strong chance of another hike ahead, and you’re looking at a meaningful tightening of financial conditions.

The Fed can lean on demand all it wants. It still can’t manufacture oil.