The six-month-long war with Iran disrupted the Federal Reserve's September interest rate decision.

The six-month-long war with Iran is pushing the Federal Reserve to a tricky policy crossroads.

Energy prices continue to rise, but the process of cooling inflation has been slow to materialize. Federal Reserve Governor Michael Barr signaled a clear interest rate hike on Tuesday, stating that the Fed should raise rates decisively if inflation does not cool sufficiently. Meanwhile, U.S. Treasury yields have climbed along with oil prices, with the 10-year Treasury yield reaching its highest level since Trump's presidency.

However, U.S. Treasury Secretary Bessant holds the opposite view. He believes the current shock is essentially a supply shock and should not be addressed by raising interest rates unless a "second- or third-order effect" occurs, especially since core inflation remains relatively mild. With August inflation data due on September 11, and only a few dozen days remaining before the September 15-16 policy meeting, policy disagreements within the Federal Reserve are rapidly translating into market pricing pressure.

Barr's hawkish signals intensify speculation about a September rate hike.

"If inflation doesn't look like it's cooling down enough, I think we should raise interest rates decisively," Barr said in a speech in Washington on Tuesday.

He pointed out that the Federal Reserve had previously suppressed inflation to just above 2%, but over the past year, factors such as tariffs, the Middle East conflict, and investment in artificial intelligence infrastructure have stalled the process of reducing inflation.

This makes the policy choices at the September meeting even more delicate. When the Fed kept interest rates unchanged in July, three officials had already voted to raise rates. Now, with August inflation data to be released four days before the meeting, if the data again shows sticky inflation, hawkish pressure within the Fed may increase further.

More importantly, the market has already begun pricing in the possibility of a rate hike at the end of the year. Regardless of whether the Fed takes action in September, its subsequent policy path is likely to become the new core of market pricing.

The oil price shock continues, and the supply shock is no longer so "temporary".

The Middle East conflict began in late February this year. Initially, the market generally expected the energy shock to last only a few weeks, but six months later, the fighting is still ongoing, and high oil prices are beginning to test the Federal Reserve's previous strategy of "waiting for the supply shock to subside on its own."

Generally speaking, central banks do not immediately raise interest rates due to rising energy prices. This is because raising interest rates does not directly increase energy supply; instead, it may further suppress demand when the economy has already been impacted.

The problem this time is that the impact has lasted significantly longer than expected. If high oil prices persist, businesses and consumers may gradually incorporate higher costs and prices into their wage, investment, and pricing decisions, and the supply shock could evolve from a one-off energy price increase into more persistent inflationary pressure.

This is precisely the "second-order effect" that the Federal Reserve is most worried about. Especially with inflation consistently above the 2% target, it is difficult for central banks to wait indefinitely for energy prices to fall on their own.

Warsh remains ambiguous, and the market is starting to bet on "high interest rates for longer."

Federal Reserve Chairman Warsh has yet to give a clear signal on September's policy, but his recent remarks have led the market to reassess the interest rate path.

In explaining the decision to keep interest rates unchanged in July, Warsh stated that the Federal Reserve needed to wait for more information, paying particular attention to factors such as supply chains, investment flows, and geopolitics. The ongoing conflict with Iran, which continues to drive up energy prices, is clearly a key variable in this context.

Meanwhile, Warsh's recent assessment that the global economy is shifting from a "global savings glut" to a "global investment boom" has been interpreted by some market participants as a signal that interest rates may remain high for an extended period. JPMorgan strategists believe that this assessment itself is not directly related to monetary policy, but the market still views it as a hawkish policy clue.

Therefore, the real suspense surrounding the September meeting is no longer just about "whether or not to raise interest rates." If the Fed raises rates, the market will further question whether there will be more rate hikes; if it chooses to hold rates steady, it will need to explain why there are still sufficient reasons to wait, given the ongoing energy shock and the lack of further improvement in inflation.

For the Federal Reserve, the Iran war is not merely a short-term oil price shock that can be easily ignored, but rather a supply shock that may gradually transmit to inflation expectations and financial conditions. Every policy signal from the September meeting could redefine the market's assessment of "how long high interest rates will last."

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