August CPI 'Just Hot Enough'? Powell Can't Cry Wolf Again

Data released by the U.S. Bureau of Labor Statistics on Friday, August 11, Eastern Time, showed that the August CPI rose 0.4% month-over-month and 3.4% year-over-year, both in line with market expectations; core CPI excluding food and energy rose 0.3% month-over-month, above the market expectation of 0.2%, and 2.4% year-over-year, in line with expectations. Against the backdrop of Thursday's PPI also running hot and international crude oil breaking above the $100 per barrel mark, this CPI report further reinforced market expectations for a Fed rate hike next week.

Interest rate futures markets immediately raised the odds of a hike significantly. After the CPI release, the market briefly pushed the probability of a 25 basis point hike at the Fed's September 15-16 meeting to about 90%, before easing slightly to around 85%, still notably higher than the roughly 70% before the CPI release. The market also began to price in a higher chance of a second hike this year. The probability of at least one hike this year rose from 94% a day earlier to 97%.

'New Fed Wire' Breaks Down CPI: Core Inflation Cooling on Annual Basis, But Short-Term Trend Reaccelerating

Nick Timiraos, chief economics correspondent at The Wall Street Journal and known as the 'New Fed Wire,' further dissected the CPI on social media.

He noted that the unrounded month-over-month increase in August core CPI was 0.29%, translating to an annualized pace of 3.5%; the three-month annualized rate rose from 1.6% in the previous month to 2%, while the six-month annualized rate rose from 2.4% to 2.6%. The 12-month year-over-year core CPI growth rate edged down from 2.5% to 2.4%, but the decline was very limited.

In other words, from a 12-month perspective, core inflation is still cooling slowly; but based on three-month and six-month indicators that better reflect recent trends, the cooling process has stalled or even reversed.

Timiraos also pointed out that core services prices excluding housing rose 0.51% month-over-month in August, the highest since January this year, and 3% year-over-year; core goods prices rose 0.11% month-over-month and 0.7% year-over-year; housing prices rose 0.26% month-over-month and 3% year-over-year.

However, Timiraos specifically highlighted an important 'noise' in the August data: telephone services prices surged 5.4% in a single month, the largest increase on record, contributing about 0.10 percentage points to core CPI.

Brian McClard, chief investment officer at Blue Trust, noted that telephone services prices have generally been in a deflationary trend for about 30 years, but showed an unusual increase in August. Timiraos responded that it was not just August; the telephone services component also significantly boosted core CPI in June.

Therefore, the upside surprise in August core CPI cannot simply be equated with a broad reacceleration of underlying U.S. inflation.

Wall Street Mainstream Shifts: Not Necessarily Inflation Out of Control, But Enough to Support a September Hike

Despite the aforementioned noise, Wall Street is increasingly leaning toward the view that the Fed will find it hard to stay on hold next week.

Kathy Bostjancic, chief economist at Nationwide, said that the renewed rise in oil, gasoline, and diesel prices raises concerns about further pass-through of energy costs to other goods and services and higher inflation expectations, so she has now shifted to expecting a Fed rate hike next week.

Stephen Juneau, senior economist at Bank of America, believes the August data alone is not enough to make him more worried about the inflation outlook. The sharp rise in telephone services prices 'tends to be noise and will reverse,' but that does not prevent the Fed from hiking next week.

Anna Wong, chief U.S. economist at Bloomberg, and economist Troy Durie also believe that the August CPI may not convince the doves within the FOMC to keep rates unchanged, and combined with the market's hawkish reaction, the Fed will likely have to hike next week.

The Wall Street Journal cited Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management, saying that while this CPI was not as 'hot' as the previous day's PPI, it still leaves the Fed with 'less room to maneuver' in defending its inflation-fighting credibility.

Skyler Weinand, chief investment officer at Regan Capital, was more direct: although August CPI was broadly in line with expectations, inflation is 'still too hot,' the Fed is 'handcuffed,' and a hike next week is 'almost certain.'

Sharif: The Fed Has Reached an 'Act or Shut Up' Moment

Among economists who have published comments so far, Omair Sharif, founder of Inflation Insights, was particularly hawkish.

Sharif said the Fed has reached an 'act or shut up' moment—if the Fed signaled at the Jackson Hole conference that action was needed, then it must deliver with a rate hike next week to back up its previous statements, otherwise it risks becoming a 'cry wolf' story.

Sharif's judgment was aimed at Fed Chair Powell's speech at the Jackson Hole central bank symposium in August. Powell said at the time that if the Fed cannot be confident that underlying inflation is moving toward the 2% target at a 'clear and fast enough' pace, policymakers 'still have work to do.'

Sharif specifically noted that there are clear anomalous factors behind the surge in wireless communication services prices in August core CPI, and if this item is excluded, the core inflation increase would be much more moderate. But the problem is that with market pricing for a hike next week briefly approaching 90%, the Fed can hardly explain away the overall data with a single anomalous component.

And now, with August core CPI rising 0.3% month-over-month, oil prices breaking above $100, and energy shocks from the Middle East situation, the policy space for Powell to stay on hold next week has clearly narrowed.

Oxford Economics Still Leaves Room: Core PCE May Rise Only 0.2%, Decision on a 'Knife's Edge'

But not all economists believe the CPI is enough to decide policy.

Oxford Economics analysts noted that the Fed's true focus is the personal consumption expenditures price index (PCE), not the CPI itself. Because some core goods prices rose relatively moderately, they expect August core PCE may rise only 0.2% month-over-month, a relatively moderate level.

If this forecast holds, the Fed still has reason to pause rate hikes next week.

However, Oxford Economics also believes the policy decision is on a 'knife's edge.'

The problem is that several other institutions expect a higher increase in August core PCE. If those forecasts materialize, they could further intensify concerns within the Fed—especially among officials who previously thought the cooling in June and July inflation might start a benign trend, who may reassess that judgment.

Reuters noted that at least two Wall Street institutions have already changed their previous policy forecasts: they had expected the Fed to stay on hold in September, but now predict a hike next week.

TD Securities strategists abandoned their hold forecast and now expect the Fed to begin the first of three rate hikes in this cycle in September.

TD strategists including Oscar Munoz and Gennadiy Goldberg wrote in a research note released Friday: 'We expect a total of three rate hikes in this cycle, with the latter two hikes in October and January next year. The Fed may not provide forward guidance, but the dot plot should lean hawkish.' The note stated: 'After the August CPI showed a lack of progress on inflation, we expect the Fed to start the hiking cycle in September.'

Hodge: Not a Reacceleration of Inflation, Just a 'Bump on the Disinflation Road'

Christopher Hodge, economist at Natixis, offered a relatively moderate judgment.

He believes the August CPI does not mean core inflation is reaccelerating, but rather is more like 'a bump on the disinflation road.'

But that does not mean he opposes a hike next week. Hodge believes the Fed may see the need to 'nudge' the economy with one or two rate hikes, and that likely starts with next week's meeting.

This judgment also explains the market's contradictory reaction: Wall Street does not necessarily think U.S. inflation has re-entered an out-of-control state, but more and more people believe that with the cooling of inflation stalling and oil prices rising again, the Fed needs to make an insurance-style policy adjustment through rate hikes.

'One Hike' or 'Re-entering a Hiking Cycle'? Wall Street Divisions Emerge

Therefore, after the August CPI release, market attention is gradually shifting from 'will the Fed hike in September' to 'what happens after a September hike.'

Peter Williams, global macro analyst at 22V Research, believes this inflation report is 'clearly not the kind the market fears most,' but it is also not a report that can completely solve the U.S. inflation problem. He believes the market's reaction to the data even suggests that inflation being 'hot enough' to prompt Fed tightening may actually be seen as a good thing, because the market had already begun to worry that policy was too loose or even inflationary.

Florian Ielpo, head of macro research and multi-asset portfolio manager at Lombard Odier Investment Managers, also believes this is clearly not the inflation report the market fears most, but it is far from completely solving the inflation problem.

Chris Zaccarelli, chief investment officer at Northlight Asset Management, said one cannot say the Fed will 'definitely' hike next week, but it is hard to imagine the Fed finding a reason to keep rates unchanged in the face of such data.

Jim Baird, chief investment officer at Plante Moran, believes August core inflation is higher than ideal, making next week's policy meeting more critical. If the Fed stays on hold again, market questions about 'what exactly is the Fed waiting for' will become sharper.

Bret Kenwell, U.S. investment and options analyst at eToro, focused on what comes after the hike. He believes that if the Fed describes this action as an 'insurance hike' against reaccelerating inflation, rather than the start of a new sustained tightening cycle, the market may interpret it as a 'dovish hike.'

In that case, short-end Treasury yields may remain elevated, but upward pressure on long-term Treasury yields may actually be contained.

Market Expectations for September Hike Run High; Whether December Sees Another Hike Becomes New Suspense

After the CPI release, interest rate futures quickly reflected this shift in policy expectations.

The market briefly pushed the probability of a September hike to about 90%, then eased to around 85%, still notably higher than the roughly 70% before the CPI release. At the same time, the likelihood of a second hike this year also increased.

This means the market debate over a September hike is rapidly cooling, and the bigger question becomes: is this an 'insurance hike' or the start of a new hiking cycle?

From Timiraos's breakdown of three-month and six-month annualized core inflation indicators, the recent inflation trend is indeed not as smooth as previously thought; from Oxford Economics' judgment, the PCE measure may be more moderate than CPI; and from the views of Hodge and others, the August data may still be just a brief reversal on the disinflation road.

Therefore, what is truly worth watching at next week's Fed meeting may not be just the 25 basis points themselves, but how Powell will explain this action and whether he will hint at the need for further rate hikes in the future.

If the Fed defines the September action as an 'insurance hike' against inflation risks, the market may view it as a 'dovish hike.' But if Powell signals continuous tightening, the repricing pressure on Treasury yields and risk assets may just be beginning.