US Fed on 'knife edge' as oil prices heap pressure on inflation risk

The US Federal Reserve finds itself on a knife edge as oil prices intensify inflation concerns driven by the Iran war. Nearly 90% of traders expect the central bank to raise interest rates by 25 basis points on Wednesday, breaking a nine-month pause. Traders fear prolonged war in the Gulf, including Yemen's Houthi rebels seizing the Red Sea port of Mokha, could keep energy prices high.

Brent crude oil settled at $104.50 per barrel after Saudi Arabia shut down the East-West Pipeline due to attacks, a key export route for the kingdom. This move could signal a critical juncture in the six-month conflict. Oil prices surged nearly 8% last week due to escalating tensions. Meanwhile, US inflation data showed headline inflation remained steady at 3.4% in August, with core inflation at 2.4%, both as expected.

However, petrol prices rose 27.4% year-on-year, and 3.9% monthly in August. The average driver now pays $4.29 per gallon, up from $3.19 last year. Diesel prices even surpassed $6 per gallon. The Fed's chairman, Kevin Warsh, feels uncertain about whether inflation is moving towards the central bank's 2% target. Compared to sitting on a "knife edge," Fed policymakers must balance economic risks and inflation control.

The bond market is also putting pressure on Fed policymakers, with US long-term yields hitting a near two-decade high due to inflation fears and mounting government debt. The Treasury Department attempted to ease borrowing costs by buying back $6 billion in government debt, but the 10-year Treasury yield rose to its highest level since 2023. To counteract bond market volatility, the Fed will need to act swiftly and credibly.