Fed Expected To Hike Rates Next Week as Inflation Remains Hot at 3.4%

The Federal Reserve is now seen as extremely likely to raise its benchmark interest rate next week, after a key inflation reading came in hot on Friday.

Investors have increasingly been eyeing a rate increase, and the probability of September rate hike surged above 90% following the latest Consumer Price Index (CPI) data release from the Labor Department, according to CME FedWatch.

The report showed prices rose 3.4% annually in August, unchanged from the prior month. But prices jumped 0.4% from June, a major surge from the last monthly increase of 0.1%.

The new CPI report is the final major economic indicator before the Federal Open Market Committee (FOMC) holds its two-day policy meeting next week, with a vote on interest rates to be held on Wednesday.

The Fed's overnight rate has held steady at a top range of 3.75% since December. An increase to 4% would mark the first rate hike in three years, with broad implications for the housing market.

Although the Fed operates under a dual mandate of price stability and maximum employment, Fed Chairman Kevin Warsh and the FOMC have been focused squarely on inflation recently, not labor.

Prediction marketplace Kalshi estimates a more conservative 75% chance that the FOMC will increase the federal funds rate from its current range.

Realtor.com® senior economist Jake Krimmel points out that while prediction markets seem convinced that a rate increase is coming, the CPI report "may prove a bit of a Rorschach test" for the FOMC, likely doing little to alter entrenched views within the central bank.

Core inflation, which strips out volatile food and energy costs—and which is watched especially closely by both the Fed and the markets—increased 0.3% month over month, exceeding consensus estimates, even as the annual rate cooled to 2.4% from 2.5% in July, continuing on a downward trajectory.

"The Fed’s ‘hold’ camp, Gov. Chris Waller among them, gets cover from a core rate that's now cooled to 2.4% year over year, three straight months of improvement," says Krimmel. "The ‘hike’ camp can feel their position confirmed too, with monthly core up 0.3%."

Notably, in his inaugural keynote address at Jackson Hole last week, Warsh stressed that "we should not rely on isolated data points. Trends matter most."

Taken together, Krimmel says that while a rate hike next week remains probable, the new inflation data "won't settle any debates in the Fed boardroom."

Energy costs drive inflation as Iran War drags on

A closer look at the August price index shows that the cost of gasoline jumped 3.9% month over month, accounting for over one third of the monthly headline inflation increase.

On an annual basis, the price of gasoline surged 27.4%, reflecting energy oil shocks caused by the ongoing U.S.-Iran war. Meanwhile, housing costs rose 0.3% from July and 3% year over year.

This latest economic print comes a day after Freddie Mac reported the 30-year fixed-home loan rate climbing to a 15-month high of 6.76%, propelled by surging 10-year Treasury yields. 

"Why CPI matters for households and housing goes beyond the Fed’s reaction function," says Krimmel. "It's about headline inflation over core; price levels over annual inflation rates; and 30-year mortgage rates over short-run rates."

The economist stresses that no matter how the Fed interprets the inflation data, all three major consumer signals are pointing in the wrong direction.

For housing, that means the late-summer slowdown might turn into a September stall, with pending sales recently turning negative year over year and existing home sales hitting their annual low in August.

"Regardless of how tomorrow’s CPI report influences next week’s Fed decision, households and the housing market need a path toward lower inflation—for purchasing power, consumer confidence, and lower mortgage rates next year," concludes Krimmel.