Why the Odds of a Fed Interest Rate Hike Just Shot Higher

Key Takeaways

• The odds of a September interest rate hike have risen to 85% from 72% a day earlier and roughly 50% a month ago.
• Friday’s change in expectations came after new inflation data showed that price pressures remain well above the Fed’s target.
• Fed officials have remained divided on policy this summer, with some favoring holding rates steady and others pushing for hikes to bring inflation down to target.

Hotter-than-expected inflation data released Friday appeared to cement the case for an interest rate hike at the Federal Reserve’s September meeting next week. The decision will be released on Wednesday.

According to the Bureau of Labor Statistics, the Consumer Price Index rose 3.4% on an annual basis and 0.4% on a monthly basis in August. The gains were broad-based and included higher gas prices stemming from the ongoing war in Iran.

Against that backdrop, the odds of a quarter-point hike are now hovering around 85%, according to CME FedWatch. Traders bet that the hot inflation data will be enough to swing the Federal Reserve Open Market Committee toward an increase. The odds of a hike were given as 72% yesterday and less than 50% a month ago.

“While this wasn’t a terribly high inflation reading, the Fed needed a core inflation reading that was much closer to a 2% annualized pace to continue holding off on rate hikes,” says Preston Caldwell, senior US economist at Morningstar. “As such, the Fed is very likely to hike the federal-funds rate at its September meeting.”

Addison Maier, a portfolio manager at Janus Henderson Investors, wrote in a note Friday that while the data held some encouraging signs, including softer goods inflation attributable to the fading impact of tariffs, it’s “too little too late to stave off a hike.”

Dynamics within the Fed are also playing a role. “Chairman Warsh’s Jackson Hole remarks, together with current market pricing, have raised the cost of disappointing expectations significantly,” wrote Bank of America economists on Friday. At that highly watched Jackson Hole speech, Warsh emphasized his commitment to fighting inflation: “Price stability is not self-executing, nor is inflation necessarily mean-reverting. It is the Fed’s job to deliver stable prices.”