The latest US inflation data for August, particularly the hotter-than-expected core reading, is increasingly being viewed as a decisive factor for the Federal Reserve's upcoming policy meeting. While some on Wall Street point to one-off elements like a surge in telephone service costs as evidence that the data doesn't prove a broad re-acceleration of price pressures, a growing number of economists argue the Fed can no longer overlook the renewed warming signals from two consecutive months of inflation figures.

Data released by the US Labor Department on Friday showed the headline consumer price index (CPI) rose 0.4% month-on-month and 3.4% year-on-year, both in line with forecasts. The core CPI, which excludes food and energy, increased 0.3% from the prior month, surpassing the 0.2% estimate, while its annual pace of 2.4% met expectations. This report has solidified market expectations for a rate increase at the Fed's September 15-16 meeting, coming on the heels of a hotter-than-expected producer price index (PPI) and with international crude oil prices breaking above the $100 per barrel threshold last week.

Interest rate futures markets reacted swiftly, boosting the probability of a 25-basis-point hike next week to a peak of roughly 90% immediately after the CPI release, before settling near 85%. That level is notably higher than the approximately 70% probability seen just before the inflation data was published. Concurrently, traders have also raised the odds of a second rate hike within the year, with the probability of at least one increase by year-end climbing from 94% to 97% in a single day.

Core Inflation Cools Year-Over-Year but Short-Term Trends Turn Up

Nick Timiraos, chief economics correspondent for The Wall Street Journal, offered a detailed breakdown of the August CPI figures on social media. He noted that the unrounded monthly increase for core CPI stood at 0.29%, translating to an annualized rate of 3.5%. More notably, the three-month annualized pace of core inflation accelerated to 2% from 1.6% in the previous reading, while the six-month annualized pace climbed to 2.6% from 2.4%.

This paints a picture of an inflation slowdown that, while still cooling on a twelve-month basis at 2.4% compared to 2.5% previously, has largely stalled or even reversed when viewed through the lens of three- and six-month trends that better capture recent momentum. Timiraos' analysis also highlighted that core services prices excluding housing rose 0.51% in August, the largest monthly gain since January, and were up 3% year-on-year. Core goods prices increased 0.11% for the month and 0.7% annually, while shelter costs rose 0.26% month-on-month and 3% versus a year ago.

However, Timiraos flagged a significant piece of noise within the August data: telephone service prices surged 5.4% month-on-month, the largest increase on record, contributing approximately 0.10 percentage points to the core CPI reading. Brian McClard, chief investment officer at Blue Trust, noted that telephone service prices have generally trended downward over the past three decades, making the August jump highly unusual. Timiraos added that this component had also noticeably boosted core CPI back in June, suggesting it is not an isolated incident but a recurring factor that complicates the latest inflation signals.

Wall Street's Consensus Shifts: Not Necessarily a Meltdown, but Enough for September Action

Despite acknowledging these distortions, the general sentiment among Wall Street economists is veering strongly toward the belief that the Fed can no longer remain on hold. Kathy Bostjancic, chief economist at Nationwide, stated that the renewed upswing in oil, gasoline, and diesel prices raises concerns about energy costs feeding through to other goods and services and pushing inflation expectations higher. Consequently, she has revised her own forecast to now expect the Fed to raise rates next week.

Stephen Juneau, senior US economist at Bank of America, argued that the August data itself is insufficient to make him more worried about the inflation outlook, reiterating that the surge in telephone service prices is often noise and likely to reverse. Nevertheless, he agrees this does not preclude the Fed from hiking at the upcoming meeting. Similarly, Anna Wong, chief US economist at Bloomberg, and economist Troy Durie contend that the August CPI may not convince dovish members of the Federal Open Market Committee (FOMC) to maintain the status quo, especially with markets already reacting with a hawkish tilt. They conclude the Fed will likely have no choice but to raise rates next week.

Quoted by The Wall Street Journal, Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management, said the CPI report, while not as hot as the previous day's PPI, leaves the Fed with less room to maneuver in safeguarding its anti-inflation credibility. Skyler Weinand, chief investment officer at Regan Capital, was more direct, asserting that despite August CPI being broadly in line with expectations, inflation remains too high, the Fed's hands are tied, and a rate hike next week is almost certain.

Sharif: It's Time for the Fed to 'Put Up or Shut Up'

Among the economists who have released their commentary, Omair Sharif, founder of Inflation Insights, delivered a notably hawkish stance. Sharif remarked that the Fed has reached a moment where it must either act on its words or stay silent. He argued that if the Fed signaled the need for action at the Jackson Hole symposium, it must follow through with a rate hike next week to avoid becoming a story of crying wolf.

Sharif's assessment targets the speech given by Fed Chair Kevin Warsh at Jackson Hole in August. At that time, Warsh indicated that policymakers still have work to do unless they are convinced that underlying inflation is moving decisively and quickly enough toward the 2% target. Sharif specifically acknowledged that the sharp increase in wireless communication service prices in the core CPI is a clear anomaly, and excluding this item would result in a much more moderate inflation print. However, the core issue now is that with market pricing for a hike next week having approached 90%, the Fed cannot easily dismiss the overall data based on a single component's aberration.

With core CPI rising 0.3% in August, combined with oil prices above $100 and energy shocks stemming from Middle East tensions, the policy space for Warsh to remain on hold next week has significantly narrowed, according to Sharif.

Oxford Economics Sees a Silver Lining, but Decision Remains on a 'Knife's Edge'

Not every economist, however, is convinced that the CPI data alone dictates policy. Analysts at Oxford Economics pointed out that the Fed's preferred inflation gauge is the personal consumption expenditures (PCE) price index, not the CPI. Given relatively moderate gains in some core goods prices, they project that the core PCE reading for August could rise by a modest 0.2%.

If this forecast holds, Oxford Economics argues the Fed would still have a reasonable justification to delay a rate increase next week. Nevertheless, they acknowledged that the policy decision is balanced on a knife's edge. The firm's view contrasts with other institutions that anticipate a higher core PCE increase, which could amplify concerns within the Fed, especially among officials who had interpreted the June and July cooling as the start of a benign trend. These officials might be compelled to reassess their assessment.

Reuters reported that at least two Wall Street firms have already changed their policy calls in response to the data, shifting from expecting the Fed to hold in September to predicting a hike next week. TD Securities strategists, including Oscar Munoz and Gennadiy Goldberg, have abandoned their forecast for a pause. They now expect the Fed to initiate a series of three rate increases, starting in September. In a research note published Friday, they wrote: "We expect a total of three hikes this cycle, with the next two in October and January. The Fed may not provide forward guidance, but the dot plot should be hawkish." The note added: "Following the August CPI showing a lack of progress on inflation, we now expect the Fed to begin the hiking cycle in September."

Hodge: A 'Bump on the Road to Disinflation', Not a Re-Acceleration

Christopher Hodge, an economist at Natixis, offered a more moderate interpretation. He views the August CPI not as a sign of re-accelerating core inflation, but rather as a bump on the road to disinflation. However, this perspective does not lead him to oppose a rate hike. Hodge believes the Fed may see it as necessary to give the economy a gentle nudge through one or two rate increases, a process likely to begin at next week's meeting.

This view neatly encapsulates the current contradictory market sentiment. Wall Street does not necessarily think US inflation is spiraling out of control, but an increasing number of analysts believe that with the disinflation process stalling and oil prices on the rise again, a rate hike serves as a prudent, insurance-style policy adjustment.

The New Divide: A Single Hike or the Start of a New Cycle?

Following the August CPI release, market attention is pivoting from whether the Fed will act in September to what happens after this move. Peter Williams, global macro analyst at 22V Research, characterized the report as clearly not the worst-case scenario markets feared, but also not one that fully resolves the US inflation problem. He suggested that the market's reaction indicates that inflation being hot enough to force Fed tightening might be perceived as a positive, given prior concerns that policy was too loose or even inflationary.

Florian Ielpo, head of macro research at Lombard Odier Investment Managers, echoed this sentiment, stating it was evidently not the inflation report the market dreaded most, but it also falls far short of completely solving the inflation dilemma. Chris Zaccarelli, chief investment officer at Northlight Asset Management, remarked that while one cannot say the Fed will definitely hike next week, it is difficult to envision the central bank finding a reason to keep rates unchanged given the data.

Jim Baird, chief investment officer at Plante Moran, believes the firmer-than-ideal core inflation print makes next week's policy meeting even more critical. If the Fed holds steady again, questions from the market about what exactly policymakers are waiting for will become more pointed. Bret Kenwell, US investment and options analyst at eToro, has shifted his focus to the post-hike scenario. He argued that if the Fed frames the move as an insurance hike against rekindled inflation rather than the start of a sustained tightening campaign, markets might interpret it as a dovish rate increase.

In that scenario, short-term Treasury yields might remain elevated, but the pressure on longer-dated yields could actually be contained, according to Kenwell.

September Hike Expectations Soar, December Becomes the New Question

The shift in policy expectations is already reflected in interest rate futures. The probability of a September hike was momentarily pushed to around 90% before settling near 85%, still significantly above the ~70% level prior to the CPI. Simultaneously, the likelihood of a second hike within the year has also increased.

This indicates that the debate over the September move is quickly subsiding, replaced by the larger question: is this an insurance-style hike or the beginning of a new tightening cycle? Timiraos' breakdown of three- and six-month annualized core inflation metrics reveals that recent trends are not as smooth as they once appeared. Meanwhile, Oxford Economics suggests the PCE measure might be more benign than the CPI. And voices like Hodge's insist that the August data might just be a temporary blip in the disinflation process.

Therefore, what truly warrants attention at next week's Fed meeting might not be the 25 basis points itself, but how Warsh articulates this action and whether he signals that further rate increases are needed. If the Fed defines the September move as an insurance hike aimed at inflation risk, the market may well treat it as a dovish one. However, if Warsh delivers signals of consecutive tightening, the repricing pressures on Treasury yields and risk assets may be just beginning.