The latest round of inflation and labor data has shifted market expectations toward a higher probability that the Federal Reserve will lift its policy rate at the September 15-16 meeting. Data released earlier this week showed producer prices climbed 5.4% in the 12 months through August, and initial claims for unemployment insurance remained consistent with a stable labor market.
Although the headline increase in the Producer Price Index was roughly in line with economists' projections, a closer look at the component figures suggested some of the progress toward lower inflation may be reversing. The PPI report indicated that renewed hostilities in the Middle East have constrained global oil distribution, and that a surge in investment related to artificial intelligence has pushed up demand for electronic components. Those pressures were reflected in August moves higher in the costs producers paid for transportation and warehousing, as well as in increased prices for hospital services and airline fares.
Federal Reserve officials will receive additional context on inflation when the monthly Consumer Price Index report is published on Friday. That CPI print, especially the core CPI measure, will help inform policymakers' assessment of whether the current policy rate is exerting sufficient downward pressure on inflation to move it toward the Fed's 2% goal. The central bank gauges inflation against a 2% target using the 12-month change in the Personal Consumption Expenditures Price Index, a series that can be estimated once CPI and PPI information is available.
The Fed has kept its policy rate at a range of 3.50% to 3.75% since December. Inflation has remained above the central bank's 2% target for five and a half years.
Analysts at Capital Economics commented on the PPI data, writing, "With the PPI data overall still looking relatively hot, the Fed seems likely to hike this year even if it doesn’t pull the trigger this month." They added that the decision on whether the central bank will move next week "still depends on the more important core CPI figure tomorrow."
Market pricing tied to Fed funds futures traded at CME Group shifted after the PPI release. Before Thursday's data, investors placed roughly a 65% probability on a quarter-point increase at the Fed's September meeting. That probability is now closer to 70% based on the futures market. Looking further ahead, prices in financial markets imply the Fed will almost certainly deliver one, if not two, additional rate hikes by year-end.
Outside the United States, central banks also responded to inflationary pressures tied to geopolitical developments. The European Central Bank raised its key policy rates earlier on Thursday, citing inflation stemming in part from the Iran conflict. Those tensions have contributed to higher energy prices, with Brent crude futures trading above $100 a barrel.
What to watch next
- The core CPI release on Friday, which market participants view as the critical data point for the Fed's September decision.
- Further movements in energy markets linked to Middle East hostilities and their potential knock-on effects for producer and consumer prices.
- Market-implied probabilities in Fed funds futures for additional rate moves through year-end.