The Federal Reserve is confronting a historic policy dilemma. Rising oil prices, fueled by Middle East tensions, are influencing current policymakers, with the shadow of the 1979 emergency monetary action known as the "Saturday Night Massacre" deeply shaping their decision-making framework.

As stagflation fears intensify, market expectations for Fed rate cuts this year have receded dramatically. Taking the September policy meeting as an example, the implied probability of a rate cut derived from futures markets has plunged to around 50%, down from approximately 90% just a month ago. This trend of diminishing expectations is consistent across all scheduled policy meetings for the year.

The Fed is widely anticipated to maintain its current stance tonight. However, Chair Jerome Powell's post-meeting press conference and the updated economic projections from Federal Open Market Committee members are expected to provide greater clarity on the policy trajectory, though widespread market optimism is lacking.

For investors, this signifies the breakdown of the "bad news is good news" trading logic that prevailed over the past two years. Although the interest-rate-sensitive Nasdaq 100 Index remains within about 5% of its all-time high, it has largely stagnated since mid-February—a period that coincides with escalating Middle East tensions and the beginning of the decline in rate-cut expectations.

**The 'Saturday Night Massacre': How a Historical Lesson Informs Current Policy** In October 1979, then-Fed Chair Paul Volcker convened an emergency meeting and implemented aggressive interest rate hikes to forcefully combat inflation. This move inflicted severe damage on global stock and bond markets, an event historically termed the "Saturday Night Massacre." The cost was exceedingly high: the US economy experienced a double-dip recession, Treasury yields soared, and President Jimmy Carter's bid for re-election was ultimately derailed.

Volcker is a personal hero whom Chair Powell has publicly expressed admiration for. Bond traders widely believe the current Fed is assessing the situation through a similar historical lens: an ounce of prevention today is worth a pound of cure tomorrow. No policymaker wishes to repeat the past mistake of being forced into implementing Volcker-style extreme tightening measures.

The lesson from the 1970s remains starkly clear: inflation spiraled out of control, exacerbated by two energy crises, and the Federal Reserve's failure to act decisively and promptly resulted in severe economic and political consequences.

**Oil Price Shock Reshapes the Path for Rate Cuts** Persistent tensions in the Middle East are transmitting to monetary policy through the channel of oil prices.

Bob Elliott, Chief Investment Officer at Unlimited Funds and a seasoned macro hedge fund manager, noted in a report, "While many hope the Fed will pivot towards easing in the face of an oil price shock, the best-case scenario is likely a hold on rates. If the situation deteriorates further, the possibility of rate hikes will increasingly come into view."

This stands in sharp contrast to the market narrative of the past two years. Previously, even amidst stubborn inflation, investors were eager to bet on the pace of Fed rate cuts. Weak economic data—including subdued job growth over the past year—was often interpreted as a "glass half full" reason to continue buying stocks.

Since restarting its easing cycle in September 2024, the Fed has implemented a total of six rate cuts, including a 25-basis-point reduction last December. However, if supply disruptions worsen significantly due to a potential blockade of the Strait of Hormuz, that cut may stand as the last for a considerable period.

**Stock Markets Have Not Fully Priced In Policy Shift Risks** Despite a significant scaling back of rate-cut expectations, some market participants appear not to have fully digested this policy signal. The Nasdaq 100 Index's proximity to its record high suggests that valuations of large-cap tech stocks have not yet fully incorporated the pressure from a tightening interest rate environment.

Aside from a few sectors that benefit from rising commodity prices, a further deterioration of the Middle East situation would represent a clear negative for the stock market. To genuinely动摇 the Fed's policy stance, the situation would likely need to become "significantly worse."