Editor's note: CPI could become the most important economic data point ahead of the Fed's September policy meeting. Previously, the Fed could still treat tariffs and energy shocks as temporary factors and cite downside risks in the labor market as a reason for patience; but the stronger-than-expected August jobs report weakened that latter rationale, shifting the focus of policy discussions back to inflation.
Mott Capital Management believes the Fed now faces not "how high CPI must be to justify a rate hike," but rather "how low CPI must be to prevent one." Markets expect August headline CPI to accelerate from 0.1% to 0.4% month-over-month, with services costs and energy prices posing further upside risks. If the data meets or exceeds expectations, the odds of a September rate hike could rise notably.
Meanwhile, the 2-year Treasury yield near 4.4% is also sending a tightening signal. However, bond yields incorporate not only policy rate expectations but also term premiums, inflation expectations, and supply-demand dynamics, so they cannot simply be read as a direct forecast of the number of future Fed hikes. What they do suggest is that markets remain wary of the risk of further monetary tightening.
The following is a translation of the original article:
CPI Is Becoming the Key Variable for the September Decision
Fed Governor Christopher Waller's recent remarks, whether intentional or not, have further heightened market attention on the August CPI report.
Waller stated that his monetary policy decisions will largely depend on economic data. If inflation continues to make progress toward the Fed's 2% target, he would support keeping policy unchanged and remain willing to be patient.
This means the August CPI could send a relatively clear signal to the market: ahead of the September 16 policy meeting, whether investors need to fully price in the possibility of a Fed rate hike.
Meanwhile, the stronger-than-expected August jobs report indicates that the U.S. labor market remains resilient. This makes it harder for the Fed to continue delaying its response to inflation risks on the grounds of an obvious weakening in employment.
Coupled with Fed Chair Warsh's remarks at the Jackson Hole global central bank symposium on August 28, unless the August CPI shows a significant downside surprise, the difficulty for the Fed to stay on hold in September may be rising.
The "burden of proof" for policy decisions may have shifted. The Fed may no longer need an exceptionally strong data point to justify a rate hike; instead, it would take a CPI reading clearly below expectations to provide sufficient grounds for keeping rates unchanged.
Market Expects Notable Rebound in Headline CPI
For this reason, the upcoming CPI report carries far greater importance than those of recent months. It could serve as the missing final piece for a September Fed rate hike. The market already anticipates relatively hot August inflation, so even if the final data merely meets expectations, it may not necessarily reduce the odds of a rate increase.
Analysts expect August headline CPI to rise 0.4% month-over-month, notably higher than July's 0.1%, with the year-over-year increase projected to hold at 3.4%. Core CPI is expected to rise 0.2% month-over-month, flat with July, while the year-over-year reading may edge down slightly from 2.5% to 2.4%. Expectations reflected in prediction markets such as Kalshi are broadly in line with these figures.
This set of forecasts reveals a divergence: the year-over-year core inflation reading may improve modestly, but driven by energy prices, the month-over-month headline inflation pace is set to accelerate noticeably. For the Fed, this suggests inflation may still be cooling gradually, yet short-term price pressures are far from gone.
More concerning is that the final data still carries the risk of coming in above market expectations.
The August ISM services survey showed a notable rise in business cost pressures. The prices paid index climbed to 72.6 from July's 70.3, also above June's 67.7. Historically, changes in this indicator have shown some synchronization with CPI trends. While the two are not strictly one-to-one correlated, the current reading suggests services inflation could remain sticky.
Energy prices could also push August inflation higher. Rising gasoline prices will show up directly in headline CPI; higher diesel prices will increase logistics and transportation costs, and may gradually feed through to a broader range of goods and services.
If headline CPI meets the market's expectation of 0.4%, while core inflation does not show a clear weakening, it will become harder for the Fed to justify that continued waiting is the more appropriate course of action.
2-Year Treasury Yield Flashes a Hawkish Signal
Beyond CPI, the 2-year U.S. Treasury yield may also be reflecting the market's assessment of the policy outlook.
Currently, the 2-year Treasury yield is near 4.4%, notably above the effective federal funds rate. The author believes this spread suggests that the bond market is pricing in further tightening of monetary conditions ahead.
Looking back at multiple monetary policy cycles since the 1990s, the 2-year Treasury yield has tended to respond relatively quickly to inflation changes and the market's view of the policy path, while adjustments to the effective federal funds rate have lagged. In some hiking cycles, the policy rate ultimately rose to levels close to the 2-year Treasury yield, and even briefly exceeded it.
If this historical relationship re-emerges, the current 2-year yield near 4.4% could imply that the Fed still has room for further rate hikes.
However, this indicator should not be interpreted mechanically. The 2-year yield not only reflects market expectations for the policy rate, but is also influenced by factors such as inflation expectations, term premiums, Treasury supply and demand, and risk appetite. As such, it is more of a comprehensive market pricing of policy tightening risks, and does not directly prove that the Fed will definitely deliver multiple rate hikes.
If CPI Runs Hot, Can the Fed Afford to Keep Waiting?
Waller holds only one vote on the FOMC, and Warsh has made clear that the Fed wants to reduce reliance on traditional forward guidance. This means that remarks from any single official cannot fully determine the outcome of the September meeting.
But that also raises a thornier question.
If Federal Reserve officials repeatedly tell the market that policy decisions will depend on incoming data, and August CPI ultimately comes in line with expectations or even higher, yet the Fed still chooses to hold rates steady, how should investors interpret the prior communication?
At that point, the market will face not just a single rate decision, but also whether the Fed's policy reaction function has shifted: what kind of data would be sufficient to trigger a rate hike, and what inflation performance would allow policymakers to maintain patience?
Therefore, the importance of August CPI extends beyond the headline number itself. It will also test whether the Fed is willing to act on the signals it has previously communicated, and whether the market can continue to rely on economic data to gauge the policy path.
If inflation comes in clearly below expectations, holding rates steady remains fully justified; but if both headline and core CPI run hot simultaneously, and a strong labor market offers no basis for delaying action, the pressure on the Fed to hike in September will increase significantly.
Market volatility may also re-amplify accordingly.
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