Source: Jinshi Data
The Federal Reserve's interest rate decision next week may hinge on the inflation data released this week, with the ultimate factor influencing the decision potentially differing by mere hundredths of a percentage point.
Market expectations are still fluctuating between a rate hike and holding steady. Investors will next focus on the Producer Price Index (PPI) for August released on Thursday and the Consumer Price Index (CPI) on Friday. If inflation data comes in significantly hotter, it would strengthen the case for a hike; if monthly inflation shows signs of cooling, Fed officials may be more inclined to keep rates unchanged.
CPI, PPI Could Become Policy Watershed
Krishna Guha, Vice Chairman of Evercore ISI and Head of Central Bank Strategy, said: "The rate decision will then largely depend on the inflation data, while also depending to some extent on the market expectations finally formed after the data release. The threshold for the Fed to raise rates is currently not strictly defined."
Wall Street economists expect the August PPI to rise 0.4% month-over-month and 5.3% year-over-year. For CPI, the market expects headline CPI to rise 0.4% month-over-month and 3.4% year-over-year, while core CPI is expected to rise 0.2% month-over-month and 2.4% year-over-year.
But the Fed's primary gauge for monetary policy formulation is not CPI or PPI, but the Personal Consumption Expenditures Price Index (PCE). This week's data will be used to estimate the PCE released at the end of the month, thereby helping policymakers judge the inflation trend.
Guha believes that if the final monthly core PCE growth corresponds to around 0.21% or 0.22%, it might lead the Federal Open Market Committee (FOMC) to choose to hold steady; if it reaches 0.23% or 0.24%, then a turn toward a hike is "quite likely."
Guha frankly stated that this kind of policy judgment precise to 0.01 percentage points is "absurd." He and other Wall Street forecasters estimate that the CPI and PPI data may ultimately point to a monthly PCE growth between 0.2% and 0.25%, meaning a very small deviation could change the policy choice.
Warsh Faces a Key Choice, Officials' Stances Are Not Aligned
This delicate policy environment also highlights the crucial role of Fed Chairman Kevin Warsh at the September meeting.
Warsh emphasized publicly at the Jackson Hole symposium that the Fed has failed to achieve its 2% inflation target for more than five years. The market interpreted this as indicating he might push for the FOMC to raise rates by 25 basis points on September 16th.
But the market hasn't formed a strong consensus on this. As of Tuesday, market pricing suggested the probability of a Fed hike was about 60%, just around the empirical dividing line often used to judge whether a central bank is likely to act.
Guha expects the probability of holding steady remains slightly higher than that of a hike, but is far from a certainty. He said this judgment is based on inflation data possibly coming in below expectations, and also that the bar for holding rates unchanged after Warsh's Jackson Hole speech, while higher than before, is "not too high to reach."
Recent Fed officials' positions have shown clear divergence. Hawkish officials like Cleveland Fed President Beth Hammack continue to advocate for a rate hike; Fed Governors Christopher Waller, Michael Barr, and New York Fed President John Williams have leaned more toward emphasizing reliance on economic data for decision-making.
Hammack's predecessor, Loretta Mester, also said on Tuesday that the Fed needs to raise rates to demonstrate its resolve to curb inflation.
"I certainly would argue for raising rates," Mester said in an interview with CNBC. "I don't think the Fed is sure to raise rates. Chairman Warsh will need to truly explain why they made the final decision at the post-meeting press conference, whatever that decision is."
PCE Revisions and Trump's Pressure Add Variables
Even after this week's inflation data settles, another layer of uncertainty remains in the Fed's policy judgment. Economists expect the PCE to undergo revisions to several key metrics soon, which may retroactively lower previously reported inflation readings by a few tenths of a percentage point.
Therefore, the September decision could be based on an extremely small data difference. Guha believes that if the market clearly leans toward pricing in a hike before the meeting and Warsh faces credibility pressure, then keeping rates unchanged would become more difficult.
Meanwhile, Trump is adding uncertainty to the policy environment. Trump threatened last Friday that he might cut off trade with countries that maintain a trade surplus with the US if the Fed doesn't cut rates. This move is seen by some as another attack on the Fed's independence and could, in turn, prompt policymakers to reinforce their stance.
Guha said: "If the market prices in a hike as clearly dominant before the meeting, it would be very difficult for Warsh to choose to hold steady. So, within this gray area, the market reaction itself could influence the final decision."
For now, the key to the September meeting is not just "whether inflation is high," but precisely which range the PCE, as reflected by the final CPI and PPI, falls into, and whether Warsh can persuade divided officials to support the ultimate policy choice.
