US inflation data due September 11 has become the deciding input for the Federal Reserve’s September 15-16 meeting, with markets pricing roughly a 58 to 60% chance of a rate hike after an unexpectedly strong jobs report and a fresh surge in oil prices. Economists polled by Reuters expect headline CPI to rise 0.4% in August, with core CPI, which strips out food and energy, up 0.2%.
Why hike odds moved so fast
Three weeks ago the debate at the Fed was mostly about how long to stay on hold. Fed Chair Kevin Warsh shifted that conversation in a hawkish speech at Jackson Hole late August, warning that the central bank could be forced to act if inflation stays elevated. The blowout August nonfarm payrolls report, released September 4, did the rest. Payrolls came in at 162,000, roughly three times the consensus estimate, and pushed CME FedWatch odds of a 25-basis-point hike at the September meeting to 58.4% within hours. The S&P 500 dropped below 7,700 on the news.
Governor Christopher Waller, speaking September 3, framed the decision in exactly those terms. If the August CPI report shows inflation continuing to cool, he said, he would be willing to keep rates unchanged. But the data runs hot, he would consider a hike. Borrowing costs are only slightly restricting demand right now, in his words, and it may not take much acceleration in prices to tip him into supporting tighter policy. Barclays economists said the jobs report marginally strengthened the case for a quarter-point increase, while calling the inflation data the next major test.
Oil is the complication
Just as the inflation picture was settling into a familiar story, energy prices broke it. Brent crude crossed $100 per barrel early Wednesday for the first time since July, after the US struck Iranian oil tankers and Iran-backed Houthis attacked Saudi Arabia. Both Brent and US crude are up more than 60% this year. The closure of the Strait of Hormuz has also squeezed liquefied natural gas supply, and the US national average diesel price hit a record $5.90 a gallon on Tuesday, according to AAA.
Because the August CPI was collected before the latest spike, Friday’s report will not capture much of the new energy inflation. That creates a forward-looking problem rather than a backward-looking one. Markets and the Fed will be looking straight through August CPI at a September and October price level that already includes $100 oil, which is why a hawkish reaction is possible even if the August print lands close to forecasts.
What it means for assets
Stocks have taken a step back from record highs. The S&P 500 fell 0.6% on Tuesday and is down less than 2% from its mid-August peak, a modest pullback given the move in oil. Bond yields have climbed more sharply, with traders bracing for either a hike this month or sustained hawkish signaling. Central banks across Europe and Asia face the same energy shock and are expected to hold or raise rather than ease.
For equity investors, the risk is concentrated in rate-sensitive sectors. Growth and technology stocks, which led the market to its records, are most exposed to a higher discount rate. Energy producers are the obvious winners of the oil move. The dollar has been uneven, weakening against the euro and the Australian dollar even as hike odds rose, partly because other central banks are also hawkish and partly because a war premium in energy cuts both ways for US assets.
The calendar is unforgiving. CPI and PPI land this week, the FOMC decision follows on September 16, and the Bank of Japan meets September 17-18 with its own hike bets rising after strong wage data. Whoever trades the next two weeks is trading central banks, not earnings, and the first hard number arrives Friday morning in Washington.
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