PPI comes in as expected, but rate-hike odds climb ahead of Fed meeting

Advisors got a preview of this week’s inflation picture Thursday as the Producer Price Index rose 0.4% in August, matching forecasts. But the more consequential number — the Consumer Price Index – lands Friday, and could tip the scales on next week’s Fed decision.

In its statement released early Thursday, the Bureau of Labor Statistics also revised July’s PPI number to a 0.1% increase. Core PPI, which excludes food and energy, increased 0.2%, in line with expectations from economists surveyed by Dow Jones Newswires and the Wall Street Journal.

The numbers are being closely watched ahead of the next meeting of the Federal Open Market Committee, which is on Sept. 15 and 16. Last month, at the Jackson Hole Economic Policy Symposium, Federal Reserve Chair Kevin Warsh appeared to keep the rate-hike door open. 

After the PPI numbers came out the CME’s FedWatch tool put the probability of a rate hike to between 3.75% and 4% at 70%, up from 62.2% just before the numbers came out. The tool, which updates in real time, put the likelihood of rates being unchanged at 30%, down from 37.8% before the PPI numbers were released.

PPI is an important indicator of inflation and follows the latest Personal Consumption Expenditures data, which came in hot last month. PCE, which is the Federal Reserve’s preferred gauge of inflation, rose 3.7% year-over-year in July, holding steady after an annual increase of 3.7% in June.

“As the conflict with Iran drags on longer than many expected, inflation pressures are becoming increasingly entrenched, leaving investors in search of a catalyst strong enough to change the inflation narrative,” said Jeffrey Roach, chief economist for LPL Financial, in a note. “At this rate, a hike in rates next week appears likely.”

This is a big week for economic data. On Friday the latest Consumer Price Index data will be released. CPI is another important measure for inflation – economists surveyed by Dow Jones Newswires and The Wall Street Journal expect August’s CPI to increase 3.4% over the last 12 months, holding steady after a 3.4% increase in July. On a seasonally adjusted basis, CPI is expected to rise 0.4% in August, after increasing 0.1% in July.

Core CPI, or the index for all items less food and energy, is expected to rise 0.2%, holding steady from a 0.2% increase in July. On a year-over-year basis, economists expect core CPI to rise 2.4%, also in line with expectations, after rising 2.5% in July.

“The first inflation data that we received this week was largely inline with expectations and shouldn’t have too much impact on the market, however, tomorrow’s inflation data is highly anticipated as the Consumer Price Index (CPI) could have a big impact on a divided Fed,” said Chris Zaccarelli, chief investment officer for Northlight Asset Management, in a statement. “A lower-than-expected CPI number tomorrow could allow the Federal Reserve some breathing room and although there would be dissents, they could remain on hold until after the election.”

The August inflation report is the factor most likely to determine the short-term direction of the U.S. Dollar Index, better known as DXY, according to Linh Tran, market analyst at XS.com. “Energy prices will likely push headline CPI higher, but the Fed will focus more closely on core CPI and the extent to which higher energy costs are spreading into services, housing, and inflation expectations,” she wrote, in a note released earlier this week. “If core CPI rises by 0.3% or more during the month, the likelihood of a Fed rate hike could be reinforced, allowing higher yields to become a genuine source of support for the USD.”

“Conversely, an increase of 0.1–0.2% could keep the Fed on the sidelines,” she added.