US CPI data this week could influence Fed rate decision: What investors must know

Investors are turning their attention to US inflation data due later this week, with the August consumer price index report expected to play a crucial role in determining whether the Federal Reserve raises interest rates at its September policy meeting.

The Bureau of Labor Statistics is expected to report on Friday that headline consumer inflation rose 3.4% year over year in August, unchanged from July, according to economists polled by Reuters.

Core CPI, which excludes volatile food and energy prices, is expected to have eased to 2.4% from 2.5%.

The figures will be closely watched after a stronger-than-expected August jobs report revived expectations for tighter monetary policy.

The US economy added 162,000 jobs last month, nearly three times the forecast, while the unemployment rate held at 4.1%.

August inflation to show whether moderation in price pressures continues

The August CPI report will provide the Federal Reserve with one of its final major pieces of economic data before policymakers meet on September 15 and 16.

July’s report showed headline inflation slowing to 3.4% from 3.5% in June, while core CPI increased 0.2% month over month.

The annual core inflation rate eased to 2.5% from 2.6%.

Therefore, investors will particularly scrutinize the core inflation reading for evidence that the recent moderation in underlying price pressures is continuing.

That trend could determine whether policymakers view inflation as moving sufficiently toward the Fed’s 2% target or whether additional tightening is necessary.

Garrett Melson, portfolio strategist at Natixis Investment Managers Solutions, said the upcoming release could prove unusually important.

“With the upcoming CPI, ‘what really matters is whether that print really confirms the cooling that we saw in June and July,’” Melson said.

“It does kind of come down to one print, in that sense.”

How core CPI data would influence Fed's rate decision

The headline inflation number could receive a boost from higher energy prices.

Barclays analysts said an increase in oil prices was likely to have contributed to August’s inflation reading, as the US war in Iran continues to disrupt global energy flows.

However, the Fed may place greater emphasis on core inflation when assessing the underlying trajectory of prices.

Energy shocks originating outside the central bank’s control are less likely to influence its longer-term policy decisions than persistent increases in services and other core prices.

According to IG.com, “A hotter print, for example core inflation at 0.3% MoM, would likely push rate hike probabilities higher again ahead of next week's Federal Open Market Committee (FOMC) meeting. A 0.1% MoM print would increase the chances the Fed stays on hold into year-end.”

Bruce Kasman, global head of economics at JPMorgan, expects core CPI to rise 0.21% month over month.

He believes such an increase would be low enough for the Fed to leave interest rates unchanged, at least for now.

Strong jobs report has complicated the outlook

The inflation data takes on greater significance following Friday’s employment report.

Nonfarm payrolls increased by 162,000 in August, well above the 55,000 expected, while employment gains in the previous two months were revised higher by a combined 55,000.

The unemployment rate remained at 4.1%, while the labor-force participation rate increased to 61.6% from 61.4%.

The stronger labor market figures pushed interest-rate expectations higher.

Fed funds futures indicated a 57% probability of a rate hike at the September meeting late Friday, while the US rates market began the week pricing in about 15 basis points of tightening for the September meeting and roughly 60 basis points of hikes through June 2027.

Barclays economists said the jobs report “marginally” strengthened the case for a quarter-percentage-point increase in September.

“Attention now shifts to next week's inflation data,” the analysts said.

Waller leaves door open to rate hike

The Fed’s own messaging has also highlighted the importance of incoming inflation data.

Fed Governor Christopher Waller said Thursday that he would support keeping rates unchanged if price pressures continue to moderate.

“If there is continued progress towards our 2 per cent goal, then I am willing to support holding the policy rate at its current level,” Waller said.

He added that an acceleration in inflation could change his view and make a rate increase appropriate.

The comments initially pushed rate-hike expectations lower, but those odds rose again following the stronger employment report.

The result leaves investors facing a relatively narrow window in which inflation data could tip the balance.

Stocks face pressure from higher yields

A higher-for-longer interest-rate outlook could weigh on US equities by increasing borrowing costs, potentially slowing economic activity and reducing corporate investment.

Higher Treasury yields can also make bonds more attractive relative to stocks while putting pressure on equity valuations, particularly for companies whose valuations depend heavily on future earnings growth.

US stocks ended mostly lower on Friday after the stronger-than-expected jobs report pushed Treasury yields and expectations for a Federal Reserve rate hike higher.

The S&P 500 fell 0.38%, while the Dow Jones Industrial Average lost about 272 points, or 0.51%. The Nasdaq Composite declined 0.29%, although the Nasdaq 100 edged higher by about 0.2%.

The benchmark 10-year Treasury yield rose to around 4.78% late Friday, moving closer to the 5% level that some investors view as potentially troublesome for equities.