Inflation risks put rate hikes back in focus
The Fed is poised to hike after hotter inflation, the ECB signals more tightening, UK headline growth masks underlying weakness, and the BoJ prepares a hawkish increase amid persistent inflation risk.
Weekly highlights
As expected
Not good enough
Anticipated hike
But weak underlying drivers
Above expectations
Above expectations
Peak goods PPI?
Slightly below expectations.
Lowest since 2013
US: Walking the walk
Any other month, we would have described the latest US inflation data as “good enough.” But not this month. Fed Chair Warsh had drastically lowered the bar for Fed hikes with his Jackson Hole speech, and FOMC commentary since then had placed disproportionate weight on the August inflation data, such that the smallest upside surprise would cement hike bets. And so it was.
Overall consumer prices rose 0.4% MoM in August, as expected, but core prices increased a larger-than-expected 0.3% MoM. So, even though the core inflation rate of 2.4% YoY was the lowest since March 2021, it seems almost guaranteed that the Fed will hike rates on September 16. We find this ironic in a sense because the CPI components that would normally worry us more as signaling sustained price pressures ahead were actually pretty reassuring. Most importantly, shelter inflation still points in the right direction, with Owners’ Equivalent Rent (OER) inflation matching the lowest post-Covid reading at 3.1% YoY. Core goods inflation sits at 0.7% YoY, down about 80 basis points from a year ago, validating our long-held assertion that tariffs would have only a modest impact on goods inflation. Similarly, we anticipate that, aside from specific categories such as airfares, there would be very modest pass-through of higher energy prices into broader goods and services inflation. Even in airfares, we believe much of the pass-through has already occurred and further price increases will hit against a more price-conscious consumer.
In short, our view has not changed, but the Fed call has. We still do not believe that the FOMC should hike for reasons we’ve highlighted repeatedly in these pages: inflation pass-through is limited and temporary; rate hikes are ineffective in resolving the oil supply shock; rate hikes are ineffective in slowing the booming AI segment but will further hurt housing; and the labor market is more vulnerable than the unemployment rate suggests.
And importantly, a decision should never rest so decisively on a single data point; it’s the “illusion of precision” at its worst. But here we are. And so, now that the Chair has talked the hawkish talk, the moment has come for the Fed to walk that walk. We do expect a rate hike at the September meeting and one more in December. Both are then likely to be unwound by the end of 2027.
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